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, 2016

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)

Indiana	35-1544218
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

200 East Jackson Muncie, Indiana	47305-2814
(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 Class	Name of each exchange on which registered
Common Stock, $0.125 stated value per share	The 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. [ ]

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 $1,016,468,000 as of the last business day of the registrant's most recently completed second fiscal quarter (June 30, 2016).

As of February 22, 2017 there were 41,248,140 outstanding common shares, without par value, of the registrant.

DOCUMENTS INCORPORATED BY REFERENCE

Documents	Part of Form 10-K into which incorporated
Portions of the Registrant’s Definitive	Part III (Items 10 through 14)
Proxy Statement for Annual Meeting of
Shareholders to be held May 1, 2017

TABLE OF CONTENTS

FIRST MERCHANTS CORPORATION

Glossary of Defined Terms			3
Statement Regarding Forward-Looking Statements			4
PART I
	Item 1.	Business	5
	Item 1A.	Risk Factors	22
	Item 1B.	Unresolved Staff Comments	25
	Item 2.	Properties	26
	Item 3.	Legal Proceedings	26
	Item 4.	Mine Safety Disclosures	26
		Supplemental Information - Executive Officers of the Registrant	27
PART II
	Item 5.	Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	28
	Item 6.	Selected Financial Data	30
	Item 7.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31
	Item 7A.	Quantitative and Qualitative Disclosure about Market Risk	48
	Item 8.	Financial Statements and Supplementary Data	49
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	104
	Item 9A.	Controls and Procedures	104
	Item 9B.	Other Information	105
PART III
	Item 10.	Directors, Executive Officers and Corporate Governance	106
	Item 11.	Executive Compensation	106
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	106
	Item 13.	Certain Relationships, Related Transactions and Director Independence	106
	Item 14.	Principal Accountant Fees and Services	106
PART IV
	Item 15.	Exhibits and Financial Statement Schedules	107

2

GLOSSARY OF DEFINED TERMS

FIRST MERCHANTS CORPORATION

Ameriana	Ameriana Bancorp, Inc., which was acquired by the Corporation on December 31, 2015.
ASC	Accounting Standards Codification
AOCI	Accumulated Other Comprehensive Income
Bank	First Merchants Bank, a wholly-owned subsidiary of the Corporation
BHC Act	Bank Holding Company Act of 1956
CET1	Common Equity Tier 1
C Financial	C Financial Corporation, which was acquired by the Corporation on April 17, 2015.
CFS	CFS Bancorp, Inc., which was acquired by the Corporation on November 12, 2013.
CMT	Constant Maturity Treasury
Community	Community Bancshares, Inc., which was acquired by the Corporation on November 7, 2014.
Corporation	First Merchants Corporation
Dodd-Frank Act	Dodd-Frank Wall Street Reform and Consumer Protection Act
ERISA	Employee Retirement Income Security Act of 1974
ESPP	Employee Stock Purchase Plan
FDIC	Federal Deposit Insurance Corporation
FDICIA	Federal Deposit Insurance Corporation Improvement Act of 1991
Federal Reserve	Federal Reserve Banking System
FHLB	Federal Home Loan Bank
FMIG	First Merchants Insurance Services, Inc., an Indiana corporation
FTE	Fully taxable equivalent
GAAP	Accounting Principles Generally Accepted in the United States of America
Indiana DFI	Indiana Department of Financial Institutions
OCC	Office of the Comptroller of the Currency
OTTI	Other-than-temporary impairment
RSA	Restricted Stock Awards
Sarbanes-Oxley Act	Sarbanes-Oxley Act of 2002
Savings Plan	The First Merchants Corporation Retirement and Income Savings Plan
SCB	SCB Bank, of which the Bank assumed substantially all the deposits and certain other liabilities and acquired certain other assets from the FDIC as receiver on February 10, 2012.
SEC	Securities and Exchange Commission
TEFRA	Tax Equivalent and Fiscal Responsibility Act. The TEFRA disallowance reduces the amount of interest expense an entity may deduct for the purpose of carrying tax-free investment securities.
Treasury	U.S. Department of Treasury
USI	USI Insurance Services, LLC

3

FORWARD-LOOKING STATEMENTS

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 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:

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

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

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

• 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

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, which opened for business in Muncie, Indiana, in March 1893. The Bank also operates Lafayette Bank and Trust and First Merchants Private Wealth Advisors (each as a division of First Merchants Bank).  The Bank includes 106 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 FMIG, 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 FMIG to USI.

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

As of December 31, 2016, the Corporation had consolidated assets of $7.2 billion, consolidated deposits of $5.6 billion and stockholders’ equity of $902 million.  As of December 31, 2016, the Corporation and its subsidiaries had 1,449 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 January 25, 2017, the Corporation, the Bank and The Arlington Bank, an Ohio savings bank ("Arlington Bank"), entered into an Agreement and Plan of Reorganization and Merger, pursuant to which Arlington Bank will, subject to the terms and conditions of the merger agreement, merge with and into the Bank, whereupon the separate corporate existence of Arlington Bank will cease and the Bank will survive. Based on the closing price of the Corporation's common stock on January 24, 2017 of $36.46 per share, the transaction value is estimated at approximately $75.8 million. The transaction is expected to be a tax-free stock exchange for Arlington Bank's shareholders who will be receiving the Corporation's common stock pursuant to the merger. Subject to Arlington Bank's shareholders’ approval of the merger, regulatory approvals and other customary closing conditions, the parties anticipate completing the merger in the second quarter of 2017. Arlington Bank's total assets as of December 31, 2016 were $309 million.

On February 17, 2017, the Corporation and Independent Alliance Banks, Inc., an Indiana corporation ("IALB"), entered into an Agreement and Plan of Reorganization and Merger, pursuant to which IALB will, subject to the terms and conditions of the merger agreement, merge with and into the Corporation, whereupon the separate corporate existence of IALB will cease and the Corporation will survive. Immediately following the merger, IALB's wholly-owned subsidiary, iAB Financial Bank, shall be merged with and into the Bank, with the Bank continuing as the surviving bank. On November 21, 2016, the Corporation purchased 495,112 shares or 12.1% of IALB's outstanding common stock from an IALB shareholder for $19.8 million. Based on the closing price of the Corporation's common stock on February 16, 2017 of $42.10 per share, the transaction value for the remaining shares of common stock, not owned by the Corporation, is approximately $251.3 million. The transaction is expected to be a tax-free stock exchange for IALB's shareholders who will be receiving the Corporation's common stock pursuant to the merger. Subject to IALB's shareholders’ approval of the merger, regulatory approvals and other customary closing conditions, the parties anticipate completing the merger in the third quarter of 2017. IALB's total assets as of December 31, 2016 were $1.1 billion.

On December 31, 2015, the Corporation acquired 100 percent of 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 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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PART I: ITEM 1. BUSINESS

On June 12, 2015, the Corporation sold all of its stock in FMIG to USI, a Delaware limited liability company. 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. 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. 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.

Effective November 12, 2013, the Corporation acquired 100 percent of 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.

Effective February 10, 2012, the Bank assumed substantially all of the deposits and certain other liabilities and acquired certain assets of SCB, a federal savings bank headquartered in Shelbyville, Indiana, from the 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 and Note 27. SUBSEQUENT EVENTS, 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 under 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 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:

• 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;

• merging or consolidating with another bank holding company; or

• 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.

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PART I: ITEM 1. BUSINESS

Basel III introduced a new capital measure 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 CET1 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 CET1 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 CET1 to risk-weighted assets ratio. The capital conservation buffer is being phased in from zero percent to 2.50 percent by 2019.

Basel III requires banking organizations to maintain:

• a minimum ratio of CET1 to risk-weighted assets of a least 4.5 percent, plus, when fully phased-in on January 1, 2019, 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)

• a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0 percent, plus, when fully phased-in on January 1, 2019, 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);

• a minimum ratio of total capital (Tier 1 plus Tier 2 capital) to risk-weighted assets of at least 8.0 percent, plus, when fully phased-in on January 1, 2019, 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

• 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 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 will 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, 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.

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PART I: ITEM 1. BUSINESS

The following are the Corporation’s regulatory capital ratios as of December 31, 2016:

	Corporation		Regulatory Minimum Requirement
Total risk-based capital to risk-weighted assets	14.21	%	8.00	%
Tier 1 capital to risk-weighted assets	12.02	%	6.00	%
Common equity tier 1 capital to risk-weighted assets	11.10	%	4.50	%
Tier 1 capital to average assets	10.54	%	4.00	%

Bank Regulation

On April 1, 2016, the Board of Directors of the Bank adopted final resolutions approving the conversion of the Bank’s banking charter from a national association to an Indiana state-chartered bank. The initial application to convert was filed with the Indiana DFI on February 9, 2016. Between the date of initial application and adoption of the final resolutions by the Bank’s Board, the Indiana DFI and the FDIC conducted a joint exam of the Bank and its banking activities. Final regulatory approval of the application was obtained at the meeting of the Members of the Indiana DFI on April 14, 2016. The Bank filed official conversion documents effective April 15, 2016. As a result of the conversion, the Indiana DFI became the Bank’s primary regulator and the FDIC became the Bank’s primary federal regulator. Upon conversion, the Bank’s official name changed from “First Merchants Bank, National Association” to “First Merchants Bank.” The conversion is not expected to affect the Bank’s operations or customers in any way, and Bank customers will continue to receive identical protection on deposits through the FDIC’s deposit insurance program.

The Indiana DFI and FDIC have the authority to issue cease-and-desist orders if they determine 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, 2016, 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 FDIC has adopted regulations to implement the prompt corrective action provisions of FDICIA.

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

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

• 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

• 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.

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PART I: ITEM 1. BUSINESS

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, 2016, 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 FDIC’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.

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

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, President Obama signed 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:

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

• 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;

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

• 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.

When Dodd-Frank became effective, it permanently raised the previous FDIC's 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 SMDIA of $250,000, at each institution.

DIVIDEND LIMITATIONS

The Corporation's principal source of funds for dividend payments to shareholders is dividends received from the Bank. Banking regulations limit the maximum amount of dividends that a bank may pay without requesting prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the bank’s retained net income (as defined) for the current year plus those for the previous two years, subject to the capital requirements described above.  As of December 31, 2016, the amount available without prior regulatory approval for 2017 dividends from the Corporation’s subsidiaries (both banking and non-banking) was $97,225,000.

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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, 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. 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.

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THE SARBANES-OXLEY ACT

The 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:

• 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);

• independence requirements for audit committee members;

• independence requirements for company auditors;

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

• 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;

• disclosure of off-balance sheet transactions;

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

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

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

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

• the formation of a public accounting oversight board; and

• 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 Balance			Interest  Income / Expense		Average Rate		Average Balance			Interest  Income / Expense		Average Rate		Average Balance			Interest  Income / Expense		Average Rate
(Dollars in Thousands)	2016							2015							2014
Assets:
Interest-bearing deposits	$	69,753		$	350	0.50	%	$	61,373		$	160	0.26	%	$	53,231		$	124	0.23	%
Federal reserve and federal home loan bank stock	24,268			1,098		4.52		37,495			1,967		5.25		42,142			2,124		5.04
Investment securities: (1)
Taxable	721,689			16,415		2.27		703,019			17,885		2.54		763,450			19,882		2.60
Tax-Exempt (2)	550,335			28,649		5.21		483,103			26,034		5.39		396,435			22,127		5.58
Total investment securities	1,272,024			45,064		3.54		1,186,122			43,919		3.70		1,159,885			42,009		3.62
Loans held for sale	4,050			372		9.19		3,725			475		12.75		6,681			485		7.26
Loans: (3)
Commercial	3,541,098			162,848		4.60		3,187,239			142,696		4.48		2,919,020			133,567		4.58
Real estate mortgage	566,050			25,156		4.44		457,013			19,457		4.26		429,384			19,812		4.61
Installment	485,111			21,926		4.52		406,163			18,177		4.48		361,484			18,175		5.03
Tax-Exempt (2)	217,696			10,039		4.61		125,699			5,322		4.23		13,511			504		3.73
Total loans	4,814,005			220,341		4.58		4,179,839			186,127		4.45		3,730,080			172,543		4.63
Total earning assets	6,180,050			266,853		4.32	%	5,464,829			232,173		4.25	%	4,985,338			216,800		4.35	%
Net unrealized gain on securities available for sale	9,969							11,800							8,921
Allowance for loan losses	(62,976		)					(62,975		)					(67,969		)
Cash and cash equivalents	105,443							98,051							87,068
Premises and equipment	96,023							82,710							75,202
Other assets	570,756							491,272							482,794
Total assets	$	6,899,265						$	6,085,687						$	5,571,354
Liabilities:
Interest-bearing deposits:
NOW accounts	$	1,427,535		$	2,579	0.18	%	$	1,109,829		$	1,374	0.12	%	$	1,066,402		$	1,110	0.10	%
Money market deposit accounts	825,681			1,705		0.21		840,084			1,768		0.21		776,712			1,572		0.20
Savings  deposits	731,902			618		0.08		614,675			672		0.11		533,080			619		0.12
Certificates and other time deposits	1,151,700			11,012		0.96		1,121,651			11,041		0.98		1,042,539			8,377		0.80
Total interest-bearing deposits	4,136,818			15,914		0.38		3,686,239			14,855		0.40		3,418,733			11,678		0.34
Borrowings	512,356			10,925		2.13		480,794			9,939		2.07		492,128			10,164		2.07
Total interest-bearing liabilities	4,649,174			26,839		0.58		4,167,033			24,794		0.60		3,910,861			21,842		0.56
Noninterest-bearing deposits	1,301,399							1,120,264							945,222
Other liabilities	64,028							44,666							39,976
Total liabilities	6,014,601							5,331,963							4,896,059
Stockholders' Equity	884,664							753,724							675,295
Total Liabilities and Stockholders' Equity	$	6,899,265		26,839		0.43		$	6,085,687		24,794		0.45		$	5,571,354		21,842		0.44
Net Interest Income				$	240,014						$	207,379						$	194,958
Net Interest Margin						3.89	%						3.80	%						3.91	%

______________________________

⁽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 2016, 2015 and 2014. These totals equal $13,541, $10,975 and $7,921,

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.

	2016 Compared to 2015 Increase (Decrease) Due To									2015 Compared to 2014 Increase (Decrease) Due To									2014 Compared to 2013 Increase (Decrease) Due To
(Dollars in Thousands, Fully Taxable Equivalent Basis)	Volume			Rate			Total			Volume			Rate			Total			Volume			Rate			Total
Interest Income:
Interest-bearing deposits	$	24		$	166		$	190		$	20		$	16		$	36		$	(49	)	$	15		$	(34	)
Federal Reserve and Federal Home Loan Bank stock	(625		)	(244		)	(869		)	(241		)	84			(157		)	411			225			636
Investment securities	3,095			(1,950		)	1,145			961			949			1,910			9,393			742			10,135
Loans held for sale	39			(142		)	(103		)	(274		)	264			(10		)	(576		)	291			(285		)
Loans	28,858			5,459			34,317			20,315			(6,721		)	13,594			33,894			(4,423		)	29,471
Totals	31,391			3,289			34,680			20,781			(5,408		)	15,373			43,073			(3,150		)	39,923
Interest Expense:
NOW accounts	463			742			1,205			47			217			264			194			(25		)	169
Money market deposit accounts	(30		)	(33		)	(63		)	132			64			196			354			(69		)	285
Savings deposits	115			(169		)	(54		)	91			(38		)	53			180			18			198
Certificates and other time deposits	292			(321		)	(29		)	672			1,992			2,664			1,966			(993		)	973
Borrowings	666			320			986			(234		)	9			(225		)	1,673			1,975			3,648
Totals	1,506			539			2,045			708			2,244			2,952			4,367			906			5,273
Change in net interest income (fully taxable equivalent basis)	$	29,885		$	2,750		32,635			$	20,073		$	(7,652	)	12,421			$	38,706		$	(4,056	)	34,650
Tax equivalent adjustment using marginal rate of 35% for 2016, 2015, and 2014							(2,566		)							(3,054		)							(1,878		)
Change in net interest income							$	30,069								$	9,367								$	32,772

INVESTMENT SECURITIES

Management evaluates securities for 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, 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, 2016 and concluded no OTTI existed in 2016.  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:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for sale at December 31, 2016
U.S. Government-sponsored agency securities	$	100					$	100
State and municipal	360,779		$	8,443	$	5,564	363,658
U.S. Government-sponsored mortgage-backed securities	313,459		1,904		3,071		312,292
Corporate obligations	31						31
Equity securities	21,820				1,039		20,781
Total available for sale	696,189		10,347		9,674		696,862
Held to maturity at December 31, 2016
U.S. Government-sponsored agency securities	22,619				479		22,140
State and municipal	224,811		3,136		1,796		226,151
U.S. Government-sponsored mortgage-backed securities	360,213		4,956		1,527		363,642
Total held to maturity	607,643		8,092		3,802		611,933
Total Investment Securities	$	1,303,832	$	18,439	$	13,476	$	1,308,795

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for sale at December 31, 2015
U.S. Government-sponsored agency securities	$	100	$	4			$	104
State and municipal	291,730		14,241		$	60	305,911
U.S. Government-sponsored mortgage-backed securities	342,550		4,234		518		346,266
Corporate obligations	31						31
Equity securities	3,912						3,912
Certificates of deposit	2,176						2,176
Total available for sale	640,499		18,479		578		658,400
Held to maturity at December 31, 2015
State and municipal	219,767		6,982		15		226,734
U.S. Government-sponsored mortgage-backed securities	398,832		7,601		787		405,646
Total held to maturity	618,599		14,583		802		632,380
Total Investment Securities	$	1,259,098	$	33,062	$	1,380	$	1,290,780

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for sale at December 31, 2014
U.S. Government-sponsored agency securities	$	100	$	9			$	109
State and municipal	216,915		11,801		$	123	228,593
U.S. Government-sponsored mortgage-backed securities	310,460		8,771		127		319,104
Corporate obligations	31						31
Equity securities	1,706						1,706
Total available for sale	529,212		20,581		250		549,543
Held to maturity at December 31, 2014
State and municipal	204,443		5,716		96		210,063
U.S. Government-sponsored mortgage-backed securities	426,645		11,527		512		437,660
Total held to maturity	631,088		17,243		608		647,723
Total Investment Securities	$	1,160,300	$	37,824	$	858	$	1,197,266

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

	2016				2015				2014
(Dollars in Thousands)	Cost		Yield		Cost		Yield		Cost		Yield
Federal Reserve and Federal Home Loan Bank stock at December 31:
Federal Reserve Bank stock					$	19,456	6.0	%	$	18,949	6.0	%
Federal Home Loan Bank stock	$	17,964	4.3	%	18,177		5.3	%	22,404		5.1	%
Total	$	17,964	4.3	%	$	37,633	5.7	%	$	41,353	5.5	%

Federal Home Loan Bank stock has 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. In 2016, the Bank redeemed all Federal Reserve Bank stock as a result of the conversion of the Bank's banking charter from a national association to an Indiana state-chartered bank.

There were no issuers included in the investment security portfolio at December 31, 2016, 2015 or 2014 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, 2016 were:

	Within 1 Year				1-5 Years				5-10 Years
(Dollars in Thousands)	Amount		Yield (1)		Amount		Yield (1)		Amount		Yield (1)
Securities available for sale December 31, 2016
U.S. Government-sponsored agency securities	$	100	—	%
State and municipal	2,617		4.3	%	$	17,068	6.0	%	$	62,241	5.1	%
	$	2,717	4.2	%	$	17,068	6.0	%	$	62,241	5.1	%

	Due After Ten Years				Equity and U.S. Government- SponsoredMortgage - Backed Securities				Total
	Amount		Yield (1)		Amount		Yield (1)		Amount		Yield (1)
U.S. Government-sponsored agency securities									$	100	—	%
State and municipal	$	281,732	4.7	%					363,658		4.8	%
Equity securities					$	20,781	—	%	20,781		—	%
Corporate obligations	31		—	%					31		—	%
U.S. Government-sponsored mortgage-backed securities					312,292		2.7	%	312,292		2.7	%
	$	281,763	4.7	%	$	333,073	2.5	%	$	696,862	3.7	%

	Within 1 Year				1-5 Years				5-10 Years
	Amount		Yield (1)		Amount		Yield (1)		Amount		Yield (1)
Securities held to maturity at December 31, 2016
U.S. Government-sponsored agency securities					$	8,120	1.8	%	$	14,499	1.8	%
State and municipal	$	2,046	4.6	%	53,801		6.2	%	47,107		5.8	%
	$	2,046	4.6	%	$	61,921	5.6	%	$	61,606	4.8	%

	Due After Ten Years				Equity and U.S. Government- SponsoredMortgage - Backed Securities				Total
	Amount		Yield (1)		Amount		Yield (1)		Amount		Yield (1)
U.S. Government-sponsored agency securities									$	22,619	—	%
State and municipal	$	121,857	4.7	%					224,811		5.3	%
U.S. Government-sponsored mortgage-backed securities					$	360,213	2.8	%	360,213		2.8	%
	$	121,857	4.7	%	$	360,213	2.8	%	$	607,643	3.7	%

_______________________________

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

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PART I: ITEM 1. BUSINESS

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, 2016 and 2015:

	Less than 12 Months				12 Months or Longer		Total
	Fair Value		Gross Unrealized Losses		Fair Value	Gross Unrealized Losses	Fair Value		Gross Unrealized Losses
Temporarily Impaired Available for Sale Securities at December 31, 2016
State and municipal	$	126,593	$	5,564			$	126,593	$	5,564
U.S. Government-sponsored mortgage-backed securities	185,544		3,071				185,544		3,071
Equity securities	18,765		1,039				18,765		1,039
Total Temporarily Impaired Available for Sale Securities	330,902		9,674				330,902		9,674
Temporarily Impaired Held to Maturity Securities at December 31, 2016
U.S. Government-sponsored agency securities	19,121		479				19,121		479
State and municipal	50,897		1,796				50,897		1,796
U.S. Government-sponsored mortgage-backed securities	109,377		1,527				109,377		1,527
Total Temporarily Impaired Held to Maturity Securities	179,395		3,802				179,395		3,802
Total Temporarily Impaired Investment Securities	$	510,297	$	13,476			$	510,297	$	13,476

	Less than 12 Months				12 Months or Longer				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
Temporarily Impaired Available for Sale Securities at December 31, 2015
State and municipal	$	7,558	$	60					$	7,558	$	60
U.S. Government-sponsored mortgage-backed securities	83,396		445		$	2,101	$	73	85,497		518
Total Temporarily Impaired Available for Sale Securities	90,954		505		2,101		73		93,055		578
Temporarily Impaired Held to Maturity Securities at December 31, 2015
State and municipal					1,982		15		1,982		15
U.S. Government-sponsored mortgage-backed securities	69,641		519		12,906		268		82,547		787
Total Temporarily Impaired Held to Maturity Securities	69,641		519		14,888		283		84,529		802
Total Temporarily Impaired Investment Securities	$	160,595	$	1,024	$	16,989	$	356	$	177,584	$	1,380

LOAN PORTFOLIO

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

	2016					2015					2014					2013					2012
(Dollars in Thousands)	Amount			%		Amount			%		Amount			%		Amount			%		Amount			%
Loans at December 31:
Commercial and industrial loans	$	1,194,646		23.2	%	$	1,057,075		22.5	%	$	896,688		22.8	%	$	761,705		21.0	%	$	622,579		21.5	%
Agricultural production financing and other loans to farmers	79,689			1.6		97,711			2.1		104,927			2.7		114,348			3.1		112,527			3.9
Real estate loans:
Construction	418,703			8.1		366,704			7.8		207,221			5.3		177,082			4.9		98,639			3.4
Commercial and farmland	1,953,062			38.1		1,802,921			38.5		1,672,661			42.6		1,611,809			44.4		1,266,682			43.6
Residential	739,169			14.4		786,105			16.7		647,315			16.5		616,385			17.0		473,537			16.3
Home equity	418,525			8.1		348,613			7.4		286,529			7.3		255,223			7.0		203,406			7.0
Individuals' loans for household and other personal expenditures	77,479			1.5		74,717			1.6		73,400			1.9		69,783			1.9		75,748			2.6
Lease financing receivables, net of unearned income	311					588					1,106					1,545					2,590			0.1
Other commercial loans	258,061			5.0		159,388			3.4		35,018			0.9		24,529			0.7		46,501			1.6
Loans	5,139,645			100.0	%	4,693,822			100.0	%	3,924,865			100.0	%	3,632,409			100.0	%	2,902,209			100.0	%
Allowance for loan losses	(66,037		)			(62,453		)			(63,964		)			(67,870		)			(69,366		)
Net Loans	$	5,073,608				$	4,631,369				$	3,860,901				$	3,564,539				$	2,832,843

Residential Real Estate Loans Held for Sale at December 31, 2016, 2015, 2014, 2013, and 2012 were $2,929,000, $9,894,000, $7,235,000, $5,331,000, and $22,300,000, respectively.

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PART I: ITEM 1. BUSINESS

At December 31, 2015, loans of $331.0 million with a fair value discount of $14.0 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 38.1 percent and 38.5 percent of loans at December 31, 2016 and 2015, respectively. Commercial and industrial loans made up 23.2 percent and 22.5 percent of loans and residential real estate loans, including home equity, made up 22.5 percent and 24.1 percent of loans at December 31, 2016 and 2015, 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, 2016. Also presented are the amounts due after one year, classified according to the sensitivity to changes in interest rates.

(Dollars in Thousands)	Maturing Within 1 Year		Maturing 1-5 Years		Maturing Over 5 Years		Total
Commercial and industrial loans	$	920,304	$	169,431	$	104,911	$	1,194,646
Agriculture production financing and other loans to farmers	71,083		7,565		1,041		79,689
Real estate loans:
Construction	387,414		20,558		10,731		418,703
Commercial and farmland	1,015,620		720,415		217,027		1,953,062
Other commercial loans	16,737		39,186		202,138		258,061
Total	$	2,411,158	$	957,155	$	535,848	$	3,904,161

(Dollars in Thousands)	Maturing 1-5 Years		Maturing Over 5 Years
Loans maturing after one year with:
Fixed rate	$	658,540	$	469,495
Variable rate	298,615		66,353
Total	$	957,155	$	535,848

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)	2016		2015		2014		2013		2012
Non-performing assets:
Non-accrual loans	$	29,998	$	31,389	$	48,789	$	56,402	$	53,399
Renegotiated loans	4,747		1,923		1,992		3,048		12,681
Non-performing loans (NPL)	34,745		33,312		50,781		59,450		66,080
Other real estate owned	8,966		17,257		19,293		22,246		13,263
Non-performing assets (NPA)	43,711		50,569		70,074		81,696		79,343
90+ days delinquent and still accruing	112		907		4,663		1,350		2,037
NPAs & 90+ days delinquent	$	43,823	$	51,476	$	74,737	$	83,046	$	81,380
Impaired loans	$	72,050	$	97,527	$	116,223	$	119,755	$	79,179

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, 2016, non-accrual loans of $29,998,000 decreased $1,391,000 from December 31, 2015. At December 31, 2015, 2014, 2013 and 2012, non-accrual loans included assets acquired during the respective periods of $2,229,000, $5,674,000, $22,703,000 and $4,219,000.

Other Real Estate Owned at December 31, 2016 decreased $8,291,000 from the December 31, 2015 balance of $17,257,000. At December 31, 2015, 2014, 2013 and 2012, other real estate owned included assets acquired during the respective periods of $5,719,000, $6,662,000, $12,899,000 and $160,000.

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PART I: ITEM 1. BUSINESS

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, 2016, interest income of $858,000 was recognized on the non-accruing and renegotiated loans listed in the table above, whereas interest income of $1,842,000 would have been recognized under their original loan terms.

At December 31, 2016, commercial impaired loans of $72,050,000 included loans acquired in prior periods totaling $46,291,000. At December 31, 2015, 2014, 2013 and 2012, commercial impaired loans included assets acquired during the respective periods of $13,206,000, $17,027,000, $69,448,000 and $17,334,000. 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, Loans Acquired with Deteriorated Credit Quality. 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 of $612,000, on a subset of commercial impaired loans totaling $3,679,000, was included in the Corporation’s December 31, 2016 allowance for loan losses. Loss reserves for acquired loans totaled $380,000, and were included in the aforementioned specific allowance.

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 andor 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 $233,538,000 as of December 31, 2016 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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PART I: ITEM 1. BUSINESS

SUMMARY OF LOAN LOSS EXPERIENCE

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

(Dollars in Thousands)	2016			2015			2014			2013			2012
Allowance for loans losses:
Balances, January 1	$	62,453		$	63,964		$	67,870		$	69,366		$	70,898
Charge Offs:
Commercial (1)	2,464			2,356			7,246			6,117			8,311
Commercial real estate (2)	2,408			1,437			6,608			7,493			12,322
Consumer	567			620			657			623			1,130
Residential	1,990			3,859			2,869			3,886			5,475
Finance leases							2			15			34
Total Charge Offs	7,429			8,272			17,382			18,134			27,272
Recoveries:
Commercial (3)	1,806			1,911			5,435			4,586			1,744
Commercial real estate (4)	2,090			2,545			3,297			3,552			3,652
Consumer	369			352			377			556			695
Residential	1,091			1,536			1,783			1,292			1,113
Finance leases							24			4			2
Total Recoveries	5,356			6,344			10,916			9,990			7,206
Net Charge Offs	2,073			1,928			6,466			8,144			20,066
Provisions for loan losses	5,657			417			2,560			6,648			18,534
Balance at December 31	$	66,037		$	62,453		$	63,964		$	67,870		$	69,366
Ratio of Net Charge Offs during the period to average loans outstanding during the period	0.04		%	0.05		%	0.17		%	0.27		%	0.71		%

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 commercial 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 commercial loans.

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

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PART I: ITEM 1. BUSINESS

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, 2016, 2015, 2014, 2013, and 2012.

	2016				2015				2014				2013				2012
(Dollars in Thousands)	Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent
Balance at December 31:
Commercial	$	27,696	29.8	%	$	26,478	28.0	%	$	28,824	26.4	%	$	27,176	24.8	%	$	25,913	26.9	%
Commercial real estate	23,661		46.2		22,145		46.2		19,327		47.9		23,102		49.3		26,703		47.1
Consumer	2,923		1.5		2,689		1.6		2,658		1.9		2,515		1.9		2,593		2.6
Residential	11,755		22.5		11,139		24.2		13,152		23.8		15,077		24.0		14,157		23.3
Finance leases	2				2				3										0.1
Totals	$	66,037	100.0	%	$	62,453	100.0	%	$	63,964	100.0	%	$	67,870	100.0	%	$	69,366	100.0	%

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, 2016, two concentrations of commercial loans within a single industry (as segregated by North American Industry Classification System “NAICS code”) were in excess of 10 percent of total loans: Lessors of Residential Buildings and Dwellings and Lessors of Nonresidential Buildings.

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 31, 2016, 2015 and 2014 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, 2016, certificates of deposit and other time deposits of $100,000 or more mature as follows:

(Dollars in Thousands)	Maturing 3 Months or Less			Maturing 3-6 Months			Maturing 6-12  Months			Maturing Over 12 Months			Total
Certificates of deposit and other time deposits	$	61,110		$	65,229		$	72,511		$	77,424		$	276,274
Percent	22		%	24		%	26		%	28		%	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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PART I: ITEM 1. BUSINESS

SHORT-TERM BORROWINGS

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

(Dollars in Thousands)	2016		2015		2014
Balance at December 31:
Federal funds purchased	$	120,349	$	49,721	$	15,381
Securities sold under repurchase agreements (short-term portion)	146,480		155,325		124,539
Federal Home Loan Bank advances  (short-term portion)	167,068		91,441		30,701
Subordinated debentures and term loans (short-term portion)	1,018		183		108
Total short-term borrowings	$	434,915	$	296,670	$	170,729

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 borrowings maturing in one year or less is summarized below:

(Dollars in Thousands)	2016			2015			2014
Weighted Average Interest Rate on Outstanding Balance at December 31:
Federal funds purchased	0.7		%	0.5		%	0.3		%
Securities sold under repurchase agreements (short-term portion)	0.3		%	0.3		%	0.3		%
Federal Home Loan Bank advances (short-term portion)	0.9		%	1.1		%	2.0		%
Subordinated debentures and term loans (short-term portion)
Total short-term borrowings	0.6		%	0.6		%	0.6		%
Weighted Average Interest Rate During the Year:
Federal funds purchased	0.7		%	0.4		%	0.4		%
Securities sold under repurchase agreements (short-term portion)	0.3		%	0.3		%	0.4		%
Federal Home Loan Bank advances (short-term portion)	1.5		%	1.1		%	0.9		%
Subordinated debentures and term loans (short-term portion)
Total short-term borrowings	0.6		%	0.5		%	0.6		%
Highest Amount Outstanding at Any Month End During the Year:
Federal funds purchased	$	120,349		$	101,249		$	121,192
Securities sold under repurchase agreements (short-term portion)	158,185			163,128			155,941
Federal Home Loan Bank advances (short-term portion)	167,068			128,557			190,709
Subordinated debentures and term loans (short-term portion)	1,018			234			470
Total short-term borrowings	$	446,620		$	393,168		$	468,312
Average Amount Outstanding During the year:
Federal funds purchased	$	15,387		$	20,767		$	44,674
Securities sold under repurchase agreements (short-term portion)	145,379			143,491			130,910
Federal Home Loan Bank advances (short-term portion)	65,789			62,471			96,284
Subordinated debentures and term loans (short-term portion)	440			174			232
Total short-term borrowings	$	226,995		$	226,903		$	272,100

21

PART I: ITEM 1A. AND ITEM 1B.

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. The Great Recession, which began in late 2007 and ended in 2009, negatively impacted the performance of commercial and consumer credit resulting in write-downs and weakening the financial condition of financial institutions. Although conditions have improved, continuation of positive economic trends cannot be certain. Worsening economic conditions in our market areas could negatively impact the financial condition, results of operations and stock price of the Corporation. For example, a prolonged economic downturn, increases 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.

• Changes in the domestic interest rate environment could reduce the Corporation’s net interest income as well as the valuation of assets and liabilities.

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. In addition to affecting profitability, changes in interest rates can impact the valuation of assets and liabilities. For example, rate changes can affect the ability of borrowers to meet obligations under variable or adjustable rate loans which in turn affect loss rates on those assets. Also, the demand for interest rate based products and services, including loans and deposit accounts, may decline resulting 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.

• 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. After the Great Recession, efforts to promote the safety and soundness of financial institutions, financial market stability, the transparency and liquidity of financial markets, and consumer and investor protection resulted in increased regulation in the financial services industry. Regulatory agencies have intensified their examination practices and enforcement of laws and regulations. Compliance with regulations and other supervisory initiatives could increase the Corporation’s expenses and reduce revenues by 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.

The banking industry, as well as the broader economy, may be subject to new legislation, regulation, and government policy. At this time, we are not able to predict the legislative and regulatory changes that may result from having a new President of the United States and from having both Houses of Congress and the White House with majority memberships from the same political party. However, both the new President and senior members of the House of Representatives have advocated for significant reduction of banking regulation, including possible amendments to the Dodd-Frank Act. Future legislation, regulation, and government policy could affect the banking industry as a whole, including our business and results of operations, in way that cannot accurately be predicted. In addition, our financial condition and results of operations also could be adversely affected by changes in the way in which existing statutes and regulations are interpreted or applied by courts and government agencies.

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PART I: ITEM 1A. AND ITEM 1B.

• 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 allowing them to aggressively price their products. In December 2016,

the OCC announced its intent to make special purpose national bank charters available to financial technology companies. The agency published a paper discussing issues related to chartering special purpose national banks and solicited public comment to help guide its approach to financial innovation. Such pressures make it more difficult for the Corporation to attract and retain customers across its business lines. Also, the demands of adapting to industry changes in technology and systems, on which the Corporation and financial services industry are highly dependent, could present operational issues and require capital spending.

• 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.

• 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.

• A disaster, natural or otherwise, acts of terrorism and political or military actions taken by the United States or other governments could adversely affect the Corporation’s business, directly or indirectly.

Disasters (such as tornadoes, floods, and other severe weather conditions, pandemics, fires, and other catastrophic accidents or events) and terrorist activities and the impact of these occurrences cannot be predicted. Such occurences could harm the Corporation’s operations and financial condition directly through interference with communications and through the destruction of facilities and operational, financial and management information systems and/or indirectly by adversely affecting economic and industry conditions. These events could prevent the Corporation from gathering deposits, originating loans and processing and controlling its flow of business by affecting borrowers, depositors, suppliers or other counterparties. The Corporation’s ability to mitigate the adverse impact these occurrences would depend in part on the Corporation’s business continuity planning, the ability to anticipate any such event occurring, the preparedness of national or regional emergency responders, and continuity planning of parties the Corporation deals with.

23

PART I: ITEM 1A. AND ITEM 1B.

• Cyber incidents and other security breaches at the Corporation, its service providers or counterparties, or in the business community or markets may negatively impact the Corporation’s business or performance.

In the ordinary course of its business, the Corporation collects, stores, and transmits sensitive, confidential, or proprietary data and other information, including intellectual property, business information, funds-transfer instructions, and the personally identifiable information of its customers and employees. The secure processing, storage, maintenance, and transmission of this information is critical to the Corporation’s operations and reputation, and if any of this information were mishandled, misused, improperly accessed, lost, or stolen or if the Corporation’s operations were disrupted, the Corporation could suffer significant financial, business, reputational, regulatory, or other damage. For example, despite security measures, the Corporation’s information technology and infrastructure may be breached through cyber-attacks, computer viruses or malware, pretext calls, electronic phishing, or other means. These risks and uncertainties are rapidly evolving and increasing in complexity, and the Corporation’s failure to effectively mitigate them could negatively impact its business and operations.

Service providers and counterparties also present a source of risk to the Corporation if their own security measures or other systems or infrastructure were to be breached or otherwise fail. Likewise, a cyber-attack or other security breach affecting the business community, the markets, or parts of them may cycle or cascade through the financial system and adversely affect the Corporation or its service providers or counterparties. Many of these risks and uncertainties are beyond the Corporation’s control.

Even when an attempted cyber incident or other security breach is successfully avoided or thwarted, the Corporation may need to expend substantial resources in doing so, may be required to take actions that could adversely affect customer satisfaction or behavior, and may be exposed to reputational damage. If a breach were to occur, moreover, the Corporation could be exposed to contractual claims, regulatory actions, and litigation by private plaintiffs, and would additionally suffer reputational harm. Despite the Corporation’s efforts to safeguard the integrity of systems and controls and to manage third-party risk, the Corporation may not be able to anticipate or implement effective measures to prevent all security breaches or all risks to the sensitive, confidential, or proprietary information that it or its service providers or counterparties collect, store, or transmit.

• 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.

• 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 GAAP 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.

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

At December 31, 2016, the Corporation had goodwill of $244,000,000 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.

• 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.

24

PART I: ITEM 1A. AND ITEM 1B.

• 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.

• 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.

• 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.

• 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.

25

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 106 banking offices operated by the Bank, 86 are owned and 20 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, 2016 was $94,432,000.

ITEM 3. LEGAL PROCEEDINGS.

There are no pending legal proceedings, other than litigation incidental to the ordinary course of business of the Corporation and 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 are no material legal proceedings 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.

26

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, 58, 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, 46, Executive Vice President and Chief Financial Officer and Chief Operating Officer, Corporation

Executive Vice President and Chief Financial Officer and Chief Operating Officer of the Corporation since May 2016; 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, 51, 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, 50, 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, 48, 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.

Jeffrey B. Lorentson, 53, 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 M. Kawiecki, 44, 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.

27

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, 2011 and tracks it through December 31, 2016.

			Period Ending
Index	12/31/2011		12/31/2012		12/31/2013		12/31/2014		12/31/2015		12/31/2016
First Merchants Corporation	$	100.00	$	176.58	$	273.16	$	277.32	$	315.00	$	475.83
Russell 2000	100.00		116.35		161.52		169.43		161.95		196.45
SNL Bank $1B-$5B	100.00		123.31		179.31		187.48		209.86		301.92
SNL Bank $5B-$10B	100.00		117.63		181.48		186.94		212.96		305.09

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

28

PART II: ITEM 5. AND ITEM 6.

STOCK INFORMATION

	Price Per Share
	HIGH				LOW				Dividends Declared (1)
Quarter	2016		2015		2016		2015		2016		2015
First quarter	$	25.27	$	23.95	$	21.10	$	21.37	$	0.11	$	0.08
Second quarter	26.55		25.38		22.63		22.09		0.14		0.11
Third quarter	27.42		26.77		23.89		24.61		0.14		0.11
Fourth quarter	38.02		27.60		25.84		24.74		0.15		0.11

Numbers rounded to nearest cent when applicable.

The table above lists per share prices and dividend payments during 2016 and 2015. 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 22, 2017, the number of shares outstanding was 41,248,140. There were 3,813 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, 2016, as follows:

Period	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as part of Publicly announced Plans or Programs	Maximum Number of Shares that may yet be Purchased Under the Plans or Programs
October, 2016
November, 2016	31,460	$32.53
December, 2016	3,198	$36.26

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, 2016. 

Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights	Weighted-average exercised price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensations plans (excluding securities reflected in first column)
Equity compensation plans approved by stockholders	260,211	$	19.26	547,181
Total	260,211	$	19.26	547,181

_______________________________

(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 17. REGULATORY CAPITAL AND DIVIDENDS to the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K include discussions regarding dividend restrictions.

29

PART II: ITEM 5. AND ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA.

(Dollars in Thousands, Except Share Data)	2016			2015			2014			2013			2012
Operations (1) (2) (3) (4) (5)
Net interest income fully taxable equivalent (FTE) basis	$	240,014		$	207,379		$	194,958		$	160,308		$	158,081
Less tax equivalent adjustment	13,541			10,975			7,921			6,043			5,745
Net interest income	226,473			196,404			187,037			154,265			152,336
Provision for loan losses	5,657			417			2,560			6,648			18,534
Net interest income after provision for loan losses	220,816			195,987			184,477			147,617			133,802
Total other income	65,203			69,868			61,816			51,831			63,699
Total other expenses	177,359			174,806			164,008			139,034			136,307
Income before income tax expense	108,660			91,049			82,285			60,414			61,194
Income tax expense	27,609			25,665			22,123			15,884			16,072
Net income	81,051			65,384			60,162			44,530			45,122
Preferred stock dividends and discount accretion										(2,380		)	(4,539		)
Net income available to common stockholders	$	81,051		$	65,384		$	60,162		$	42,150		$	40,583
Per Share Data
Basic net income available to common stockholders	$	1.99		$	1.73		$	1.66		$	1.42		$	1.42
Diluted net income available to common stockholders	1.98			1.72			1.65			1.41			1.41
Cash dividends paid - common	0.54			0.41			0.29			0.18			0.10
December 31 book value - common	22.04			20.91			19.29			17.67			16.08
December 31 tangible book value - common	15.85			14.68			13.65			12.17			10.95
December 31 market value (bid price) - common	37.65			25.42			22.75			22.72			14.84
Average Balances (1) (2) (3) (4) (5)
Total assets	$	6,899,265		$	6,085,687		$	5,571,354		$	4,455,411		$	4,245,996
Total loans (6)	4,814,005			4,179,839			3,730,080			3,008,555			2,819,816
Earning assets	6,180,050			5,464,829			4,985,338			4,017,247			3,833,174
Total deposits	5,438,217			4,806,503			4,363,955			3,465,640			3,263,020
Total stockholders' equity	884,664			753,724			675,295			540,255			535,497
Year-End Balances (1) (2) (3) (4) (5)
Total assets	$	7,211,611		$	6,761,003		$	5,824,127		$	5,437,262		$	4,304,821
Total loans (6)	5,142,574			4,703,716			3,932,100			3,637,740			2,924,509
Allowance for loan losses	66,037			62,453			63,964			67,870			69,366
Total deposits	5,556,498			5,289,647			4,640,694			4,231,468			3,346,383
Total stockholders' equity	901,657			850,509			726,827			634,923			552,236
Financial Ratios (1) (2) (3) (4) (5)
Return on average assets	1.17		%	1.07		%	1.08		%	0.95		%	0.96		%
Return on average stockholders' equity	9.16			8.67			8.91			7.80			7.58
Average earning assets to total assets	89.58			89.80			89.48			90.17			90.28
Allowance for loan losses as % of total loans	1.28			1.33			1.63			1.87			2.37
Dividend payout ratio	27.27			23.84			17.58			12.77			7.09
Average stockholders' equity to average assets	12.82			12.39			12.12			12.13			12.61
Tax equivalent yield on earning assets	4.32			4.25			4.35			4.40			4.74
Cost of supporting liabilities	0.43			0.45			0.44			0.41			0.62
Net interest margin on earning assets	3.89			3.80			3.91			3.99			4.12

⁽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 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 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. 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. 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. 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.

30

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 – 2016

Net income available to stockholders was $81.1 million, an increase of $15.7 million, compared to $65.4 million during the same period in 2015. Earnings per fully diluted common share for 2016 totaled $1.98, an increase of $0.26 per share, or 15.1 percent, over $1.72 in 2015.

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 the 2014 and 2015 acquisitions and 2015 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, 2016, total assets equaled $7.2 billion compared to $6.8 billion as of year end 2015, resulting from organic growth of $450.6 million. Total loans equaled $5.1 billion as of December 31, 2016, reflecting organic growth of $445.8 million, or 9.5%, from the same period in 2015.  

The Corporation’s allowance for loan losses totaled $66.0 million as of December 31, 2016, compared to $62.5 million as of December 31, 2015. The allowance provides 220.1 percent coverage of all non-accrual loans and 1.28 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's investment securities portfolio increased $27.5 million from December 31, 2015, and totaled $1.3 billion as of December 31, 2016. Details of the composition of the Corporation's investment securities portfolio is included within Note 4. INVESTMENT SECURITIES of the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.

As discussed within Note 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, of the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K, the Bank’s banking charter was converted from a national association to an Indiana state-chartered bank in April 2016. As part of the conversion, the Bank redeemed all of its Federal Reserve Bank stock, held and redeemed at cost, which resulted in a decrease in Federal Reserve and Federal Home Loan Bank stock of $19.7 million from the same period in 2015.

At December 31, 2016, other real estate owned totaled $9.0 million, a decrease of $8.3 million, or 48.0 percent, from the December 31, 2015 balance of $17.3 million. Included in the December 31, 2015 balance was $5.7 million of other real estate owned acquired in the Ameriana acquisition.

Taxes, both current and deferred, decreased in 2016 by $7.6 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 21. INCOME TAX of the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.

Deposits increased $266.9 million from December 31, 2015. Demand deposits, brokered certificates of deposit and savings deposits increased $290.6 million, $66.9 million and $42.0 million, respectively, from the same period in 2015. Offsetting these increases were decreases in certificates of deposit of $85.2 million and certificates of deposit greater than $100,000 of $47.4 million.

Federal Funds purchased and Federal Home Loan Bank Advances, which increased $70.6 million and $63.3 million, respectively, when coupled with the increase in deposits, were used as liquidity sources to support the increase in the loan portfolio. Additional details related to the changes 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.

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 21. 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.

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

NET INTEREST INCOME

Net interest income is the most significant component of the Corporation's earnings, comprising 78 percent of revenues for the year ended December 31, 2016. Net interest income and margin are influenced by many factors, primarily the volume and mix of earnings assets, funding sources, and interest rate fluctuations. Other factors include the level of accretion income on purchased loans, prepayment risk on mortgage and investment-related assets, and the composition and maturity of earning assets and interest-bearing liabilities. Loans typically generate more interest income than investment securities with similar maturities. Funding from client deposits generally costs less than wholesale funding sources. Factors such as general economic activity, Federal Reserve Board monetary policy, and price volatility of competing alternative investments, can also exert significant influence on our ability to optimize the mix of assets and funding and the net interest income and margin.

Net interest income is the excess of interest received from earning assets over interest paid on interest-bearing liabilities. For analytical purposes, net interest income is also presented on an FTE basis in the table that follows to reflect what our tax-exempt assets would need to yield in order to achieve the same after-tax yield as a taxable asset. The federal statutory rate in effect of 35 percent was used for all periods, adjusted for the TEFRA interest disallowance applicable to certain tax-exempt obligations. This analysis portrays the income tax benefits associated in tax-exempt assets and helps to facilitate a comparison between taxable and tax-exempt assets. Management believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully taxable equivalent basis. Therefore, management believes these measures provide useful information for both management and investors by allowing them to make peer comparisons.

For the periods presented, the increases in net interest income were primarily driven by core organic loan growth and an increase in earning assets attributable to acquisitions of C Financial in April 2015 and Ameriana in December 2015. In addition, 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.

Net interest margin for 2016 increased to 3.89 percent compared to 2015 of 3.80 percent. Asset yields increased 7 basis points FTE and interest costs decreased 2 basis points, resulting in a 9 basis point FTE increase in net interest margin as compared to 2015. Primarily as a result of organic loan growth, earning assets increased $715,221,000 in 2016 compared to 2015. The Corporation recognized fair value accretion income on purchased loans, which is included in interest income, of $12,397,000 and $8,217,000, respectively, for the twelve months ended December 31, 2016 and 2015.

Net interest margin for 2015 decreased to 3.80 percent compared to 2014 of 3.91 percent. Asset yields decreased 10 basis points FTE and interest costs increased 1 basis point, resulting in an 11 basis point FTE decrease in net interest margin as compared to 2014. Primarily as a result of the acquisitions, earning assets increased $479,491,000 in 2015 compared to 2014. The Corporation recognized fair value accretion income on purchased loans, which is included in interest income, of $8,217,000 and $8,883,000, respectively, for the twelve months ended December 31, 2015 and 2014.

Additional details of the Corporation's acquisitions, remaining loan fair value discount, accretable and nonaccretable yield can be found in Note 2. ACQUISITIONS AND DIVESTITURES and Note 6. ACCOUNTING FOR CERTAIN LOANS ACQUIRED IN A PURCHASE, included within the Notes to Consolidated Financial Statements of this Annual Report on Form 10-K.

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 2016.

	Average Balance			Interest  Income / Expense		Average Rate		Average Balance			Interest  Income / Expense		Average Rate		Average Balance			Interest  Income / Expense		Average Rate
(Dollars in Thousands)	2016							2015							2014
Assets:
Interest-bearing deposits	$	69,753		$	350	0.50	%	$	61,373		$	160	0.26	%	53,231			124		0.23	%
Federal reserve and federal home loan bank stock	24,268			1,098		4.52		37,495			1,967		5.25		42,142			2,124		5.04
Investment securities: (1)
Taxable	721,689			16,415		2.27		703,019			17,885		2.54		763,450			19,882		2.60
Tax-Exempt (2)	550,335			28,649		5.21		483,103			26,034		5.39		396,435			22,127		5.58
Total investment securities	1,272,024			45,064		3.54		1,186,122			43,919		3.70		1,159,885			42,009		3.62
Loans held for sale	4,050			372		9.19		3,725			475		12.75		6,681			485		7.26
Loans: (3)
Commercial	3,541,098			162,848		4.60		3,187,239			142,696		4.48		2,919,020			133,567		4.58
Real estate mortgage	566,050			25,156		4.44		457,013			19,457		4.26		429,384			19,812		4.61
Installment	485,111			21,926		4.52		406,163			18,177		4.48		361,484			18,175		5.03
Tax-Exempt (2)	217,696			10,039		4.61		125,699			5,322		4.23		13,511			504		3.73
Total loans	4,814,005			220,341		4.58		4,179,839			186,127		4.45		3,730,080			172,543		4.63
Total earning assets	6,180,050			266,853		4.32	%	5,464,829			232,173		4.25	%	4,985,338			216,800		4.35	%
Net unrealized gain on securities available for sale	9,969							11,800							8,921
Allowance for loan losses	(62,976		)					(62,975		)					(67,969		)
Cash and cash equivalents	105,443							98,051							87,068
Premises and equipment	96,023							82,710							75,202
Other assets	570,756							491,272							482,794
Total assets	$	6,899,265						$	6,085,687						$	5,571,354
Liabilities:
Interest-bearing deposits:
NOW accounts	$	1,427,535		$	2,579	0.18	%	$	1,109,829		$	1,374	0.12	%	$	1,066,402		$	1,110	0.10	%
Money market deposit accounts	825,681			1,705		0.21		840,084			1,768		0.21		776,712			1,572		0.20
Savings  deposits	731,902			618		0.08		614,675			672		0.11		533,080			619		0.12
Certificates and other time deposits	1,151,700			11,012		0.96		1,121,651			11,041		0.98		1,042,539			8,377		0.80
Total interest-bearing deposits	4,136,818			15,914		0.38		3,686,239			14,855		0.40		3,418,733			11,678		0.34
Borrowings	512,356			10,925		2.13		480,794			9,939		2.07		492,128			10,164		2.07
Total interest-bearing liabilities	4,649,174			26,839		0.58		4,167,033			24,794		0.60		3,910,861			21,842		0.56
Noninterest-bearing deposits	1,301,399							1,120,264							945,222
Other liabilities	64,028							44,666							39,976
Total liabilities	6,014,601							5,331,963							4,896,059
Stockholders' Equity	884,664							753,724							675,295
Total Liabilities and Stockholders' Equity	$	6,899,265		26,839		0.43		$	6,085,687		24,794		0.45		$	5,571,354		21,842		0.44
Net Interest Income				$	240,014						$	207,379						$	194,958
Net Interest Margin						3.89	%						3.80	%						3.91	%

⁽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 2016, 2015 and 2014. These totals equal $13,541, $10,975 and $7,921,

respectively.

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

NON-INTEREST INCOME

Non-interest income decreased $4.7 million, or 6.7 percent, in 2016 compared to 2015. The sale of FMIG in June 2015 resulted in a gain of $8.3 million, and also accounted for a $4.1 million decline in insurance commission income compared to 2015. Meanwhile, the larger customer base resulting from the C Financial and Ameriana acquisitions as well as organic growth contributed to increases in other customer fees, service charges and derivative hedge income of $2.4 million, $1.6 million and $1.2 million, respectively. Additional details of the divestiture and 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.

Additionally, 2016 contained an increase of $1.4 million in earnings on cash surrender value of life insurance when compared to 2015. The increase was primarily due to death benefits from Bank Owned Life Insurance of $643,000 as well as earnings on a larger portfolio resulting from the Ameriana acquisition, which included a $28.2 million Bank Owned Life Insurance portfolio.

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Finally, offsetting the increases noted above, 2015 included a gain from the Corporation's cancellation of $5.0 million of subordinated debentures, which resulted in a decline in non-interest income of $1.3 million.

In 2015, non-interest income increased $8.1 million, or 13.0 percent, in comparison 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 investment securities and earnings on cash surrender value of life insurance of $911,000 and $740,000, respectively. The decrease in gains on the sale of 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.

NON-INTEREST EXPENSES

Non-interest expenses increased $2.6 million, or 1.5 percent, in 2016 compared to 2015. Overall, the sale of FMIG resulted in the elimination of $3.2 million of non-interest expenses in 2016 compare to 2015.

Salaries and employee benefit expenses of $102.6 million increased $644,000 in 2016 compared to 2015.

• The sale of FMIG resulted in the elimination of $2.5 million of salaries and employee benefit expenses in 2016.

• The C Financial and Ameriana acquisitions resulted in one-time severance expenses of $2.0 million in 2015.

• The Corporation elected to terminate a post retirement benefit plan in 2016 which resulted in a $2.2 million curtailment gain recorded as a reduction of salaries and employee benefits expense in 2016.

• The additional personnel from the C Financial and Ameriana acquisitions, along with annual and merit increases, resulted in additional salaries and employee benefit expenses in 2016 of $7.3 million when compared to the same period in 2015.

Furthermore, as a result of the larger franchise size from the acquisitions, the Corporation experienced increases in net occupancy, outside data processing and equipment expenses of $2.3 million, $2.0 million and $1.7 million, respectively. Offsetting these increases was a $3.3 million decrease, from 2016 to 2015, in professional and other outside services due primarily to the prior year containing acquisition and divestiture expenses not repeated in the current year.

In 2015, non-interest expenses increased $10.8 million, or 6.6 percent, in comparison 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 $951,000, respectively.

INCOME TAX EXPENSE

Income tax expense in 2016 was $27,609,000 on pre-tax income of $108,660,000, or 25.4 percent. For the same period in 2015, income tax expense was $25,665,000 on pre-tax income of $91,049,000, or 28.2 percent. The decrease in the effective tax rate in 2016 when compared to 2015 was primarily a result of a permanent book-to-tax basis difference associated with the gain on sale of FMIG in 2015. 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 21. 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, CET1, 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.  

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 CET1 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 CET1 capital to risk-weighted assets ratio. The capital conservation buffer is being phased in from zero percent to 2.50 percent by 2019. As of January 1, 2016, the Corporation is required to hold a capital conservation buffer of 0.625 percent, increasing by that amount each successive year until 2019. Under Basel III, the Corporation and Bank elected to opt-out of including accumulated other comprehensive income in regulatory capital.

As of December 31, 2016, 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, 2016 and December 31, 2015 were as follows:

					Prompt Corrective Action Thresholds
	Actual				Adequately Capitalized				Well Capitalized
December 31, 2016	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total risk-based capital to risk-weighted assets
First Merchants Corporation	$	851,521	14.21	%	$	479,470	8.00	%	N/A		N/A
First Merchants Bank	800,598		13.30		481,490		8.00		$	601,862	10.00	%
Tier 1 capital to risk-weighted assets
First Merchants Corporation	$	720,484	12.02	%	$	359,603	6.00	%	N/A		N/A
First Merchants Bank	734,561		12.20		361,117		6.00		$	481,490	8.00	%
Common equity tier 1 capital to risk-weighted assets
First Merchants Corporation	$	665,445	11.10	%	$	269,702	4.50	%	N/A		N/A
First Merchants Bank	734,561		12.20		270,838		4.50		$	391,210	6.50	%
Tier 1 capital to average assets
First Merchants Corporation	$	720,484	10.54	%	$	273,456	4.00	%	N/A		N/A
First Merchants Bank	734,561		10.78		272,461		4.00		$	340,576	5.00	%

					Prompt Corrective Action Thresholds
	Actual				Adequately Capitalized				Well Capitalized
December 31, 2015	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total risk-based capital to risk-weighted assets
First Merchants Corporation	$	783,776	14.94	%	$	419,809	8.00	%	N/A		N/A
First Merchants Bank	739,793		13.98		423,242		8.00		$	529,052	10.00	%
Tier 1 capital to risk-weighted assets
First Merchants Corporation	$	656,323	12.51	%	$	314,857	6.00	%	N/A		N/A
First Merchants Bank	677,340		12.80		317,431		6.00		$	423,242	8.00	%
Common equity tier 1 capital to risk-weighted assets
First Merchants Corporation	$	603,063	11.49	%	$	236,143	4.50	%	N/A		N/A
First Merchants Bank	677,340		12.80		238,074		4.50		$	343,884	6.50	%
Tier 1 capital to average assets
First Merchants Corporation	$	656,323	10.85	%	$	242,001	4.00	%	N/A		N/A
First Merchants Bank	677,340		11.22		241,423		4.00		$	301,779	5.00	%

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PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management believes that all of the above capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation. Traditionally, the banking regulators have assessed bank and bank holding company capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations. The Federal Reserve focuses its assessment of capital adequacy on a component of Tier 1 capital known as CET1. Because the Federal Reserve has long indicated that voting common shareholders' equity (essentially Tier 1 risk-based capital less preferred stock and non-controlling interest in subsidiaries) generally should be the dominant element in Tier 1 risk-based capital, this focus on CET1 is consistent with existing capital adequacy categories. 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.

	December 31, 2016						December 31, 2015
	First Merchants Corporation			First Merchants Bank			First Merchants Corporation			First Merchants Bank
Total Risk-Based Capital
Total Stockholders' Equity (GAAP)	$	901,657		$	973,641		$	850,509		$	927,774
Adjust for Accumulated Other Comprehensive (Income) Loss (1)	13,581			9,701			1,362			(579		)
Less: Preferred Stock	(125		)	(125		)	(125		)	(125		)
Add: Qualifying Capital Securities	55,415						55,776
Less: Tier 1 Capital Deductions	(376		)				(2,516		)	(1,903		)
Less: Disallowed Goodwill and Intangible Assets	(249,104		)	(248,656		)	(247,006		)	(246,558		)
Less: Disallowed Servicing Assets
Less: Disallowed Deferred Tax Assets	(564		)				(1,677		)	(1,269		)
Total Tier 1 Capital (Regulatory)	720,484			734,561			656,323			677,340
Qualifying Subordinated Debentures	65,000						65,000
Allowance for Loan Losses Includible in Tier 2 Capital	66,037			66,037			62,453			62,453
Total Risk-Based Capital (Regulatory)	$	851,521		$	800,598		$	783,776		$	739,793
Net Risk-Weighted Assets (Regulatory)	$	5,993,381		$	6,018,623		$	5,247,617		$	5,290,524
Average Assets	$	6,836,412		$	6,811,519		$	6,050,023		$	6,035,575
Total Risk-Based Capital Ratio (Regulatory)	14.21		%	13.30		%	14.94		%	13.98		%
Tier 1 Capital to Risk-Weighted Assets	12.02		%	12.20		%	12.51		%	12.80		%
Tier 1 Capital to Average Assets	10.54		%	10.78		%	10.85		%	11.22		%
Common Equity Tier 1 Capital Ratio
Total Tier 1 Capital (Regulatory)	$	720,484		$	734,561		$	656,323		$	677,340
Less: Qualified Capital Securities	(55,415		)				(55,776		)
Add: Additional Tier 1 Capital Deductions	376						2,516
Less: Preferred Stock
Common Equity Tier 1 Capital (Regulatory)	$	665,445		$	734,561		$	603,063		$	677,340
Net Risk-Weighted Assets (Regulatory)	$	5,993,381		$	6,018,623		$	5,247,617		$	5,290,524
Common Equity Tier 1 Capital Ratio (Regulatory)	11.10		%	12.20		%	11.49		%	12.80		%

⁽¹⁾ Includes net unrealized gains or losses on available for sale securities, net gains or losses on cash flow hedges, and amounts resulting from the application of the applicable accounting guidance for defined benefit and other postretirement plans.

Additionally, management believes the following tables are also meaningful when considering performance measures of the Corporation. Non-GAAP financial measures such as tangible book value per common share, tangible common equity to tangible assets, return on average tangible capital and return on average tangible assets are important measures of the strength of the Corporation's capital and ability to generate earnings on tangible common equity invested by our shareholders. These non-GAAP measures provide useful supplemental information and may assist investors in analyzing the Corporation’s capital position without regard to the effects of intangible assets and preferred stock. Disclosure of these measures also allows analysts and banking regulators to assess our capital adequacy on these same bases.

Because these measures are not defined in GAAP or federal banking regulations, they are considered non-GAAP financial measures. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP.

37

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The Corporation had a strong capital position as evidenced by the tangible common equity to tangible assets ratio of 9.24 percent at December 31, 2016, and 9.08 percent at December 31, 2015.

	Tangible Common Equity to Tangible Assets (non-GAAP)
(Dollars in Thousands, Except Per Share Amounts)	December 31, 2016			December 31, 2015
Total Stockholders' Equity (GAAP)	$	901,657		$	850,509
Less: Cumulative preferred stock (GAAP)	(125		)	(125		)
Less: Intangible assets, net of tax (GAAP)	(258,866		)	(259,764		)
Tangible common equity (non-GAAP)	$	642,666		$	590,620
Total assets (GAAP)	$	7,211,611		$	6,761,003
Less: Intangible assets, net of tax (GAAP)	(258,866		)	(259,764		)
Tangible assets (non-GAAP)	$	6,952,745		$	6,501,239
Tangible common equity to tangible assets (non-GAAP)	9.24		%	9.08		%

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, 2016 and 2015.

(Dollars in Thousands, Except Per Share Amounts)	December 31, 2016			December 31, 2015
Average goodwill (GAAP)	$	244,000		$	206,032
Average core deposit intangible (GAAP)	16,800			14,859
Average deferred tax on CDI (GAAP)	(6,468		)	(5,610		)
Intangible adjustment (non-GAAP)	$	254,332		$	215,281
Average stockholders' equity (GAAP)	$	884,664		$	753,724
Average cumulative preferred stock (GAAP)	(125		)	(125		)
Intangible adjustment (non-GAAP)	(254,332		)	(215,281		)
Average tangible capital (non-GAAP)	$	630,207		$	538,318
Average assets (GAAP)	$	6,899,265		$	6,085,687
Intangible adjustment (non-GAAP)	(254,332		)	(215,281		)
Average tangible assets (non-GAAP)	$	6,644,933		$	5,870,406
Net income available to common stockholders (GAAP)	$	81,051		$	65,384
CDI amortization, net of tax (GAAP)	2,542			1,720
Tangible net income available to common stockholders (non-GAAP)	$	83,593		$	67,104
Per Share Data:
Diluted net income available to common stockholders (GAAP)	$	1.98		$	1.72
Diluted tangible net income available to common stockholders (non-GAAP)	$	2.04		$	1.76
Ratios:
Return on average GAAP capital (ROE)	9.16		%	8.67		%
Return on average tangible capital	13.26		%	12.47		%
Return on average assets (ROA)	1.17		%	1.07		%
Return on average tangible assets	1.26		%	1.14		%

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.

38

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 of the loan portfolio and amount of non-performing loans may increase or decrease 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 internal management.

At December 31, 2016, non-performing loans totaled $34,745,000, an increase of $1,433,000 from December 31, 2015. Troubled Debt Restructured loans of $4,747,000 increased $2,824,000 from December 31, 2015. The increase in Troubled Debt Restructures was primarily in the loans secured by commercial real estate category, which increased $3,085,000 year over year. Loans not accruing interest income totaled $29,998,000 at December 31, 2016, a decrease of $1,391,000 from the December 31, 2015 balance of $31,389,000. The Corporation's coverage ratio of allowance for loan losses to non-accrual loans increased from 199.0 percent at December 31, 2015 to 220.1 percent at December 31, 2016. 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 $8,966,000 declined $8,291,000 during the twelve month period ending December 31, 2016.  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 of $112,000 at December 31, 2016 decreased $795,000 from the December 31, 2015 balance of $907,000. First lien residential real estate and revolving home equity line of credit loans 90+ days delinquent and accruing decreased $493,000 and $297,000, respectively, from December 31, 2015.

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 contractually past due 90 days or more and troubled debt restructure loans.

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, 2016, commercial impaired loans totaled $72,050,000, a decrease of $25,477,000 from December 31, 2015. At December 31, 2016, a specific allowance for losses was not deemed necessary for commercial impaired loans totaling $68,371,000 as there was no identified loss on these credits. An allowance of $612,000 was recorded for the remaining balance of these impaired loans totaling $3,679,000 and is included in the Corporation’s allowance for loan losses.

At December 31, 2016, non-performing assets, which includes non-accrual loans, renegotiated loans, and other real estate owned, plus loans 90-days delinquent, totaled $43,823,000, a decrease of $7,653,000 from December 31, 2015 as presented in the table below.

	December 31,		December 31,
(Dollars in Thousands)	2016		2015
Non-performing assets:
Non-accrual loans	$	29,998	$	31,389
Renegotiated loans	4,747		1,923
Non-performing loans (NPL)	34,745		33,312
Other real estate owned	8,966		17,257
Non-performing assets (NPA)	43,711		50,569
90+ days delinquent and still accruing	112		907
NPAs & 90+ days delinquent	$	43,823	$	51,476
Impaired loans (includes substandard, doubtful and loss)	$	72,050	$	97,527

The non-accrual balances in the table above include troubled debt restructurings totaling $4,478,000 and $5,339,000 as of December 31, 2016 and December 31, 2015, respectively.

39

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

	December 31,		December 31,
(Dollars in Thousands)	2016		2015
Non-performing assets and 90+ days delinquent:
Commercial and industrial loans	$	2,138	$	5,544
Agricultural production financing and other loans to farmers	1,341		827
Real estate loans
Construction	5,312		9,345
Commercial and farmland	22,362		18,243
Residential	10,943		14,528
Home equity	1,688		2,665
Individual's loans for household and other personal expenditures	39		324
Non-performing assets plus 90+ days delinquent	$	43,823	$	51,476

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.

Concentrations of credit in the portfolio, including commercial construction and land development loans, are closely monitored by management. Commercial construction and land development loans represented 8.1 percent of loans at December 31, 2016, a slight increase from 7.8 percent at December 31, 2015.

In 2016, total net charge offs totaled $2,073,000, an increase of $145,000 from 2015, but a decrease of $4,393,000 from 2014.  The Corporation incurred two commercial loan charge offs over $500,000 in 2016 totaling $1,917,000.  One recovery over $500,000 equaling $604,000, was recognized during the year.  Commercial and Industrial loans accounted for $600,000, or 28.9 percent of total net charge offs, compared to a net recovery of $302,000 in 2015. Residential real estate loans accounted for 24.7 percent and 67.3 percent of total net charge offs in 2016 and 2015, respectively.

The Corporations loan loss experience is presented in the table below for the years indicated.

(Dollars in Thousands)	2016			2015			2014
Allowance for loan losses:
Balance at January 1	$	62,453		$	63,964		$	67,870
Charge offs	7,429			8,272			17,382
Recoveries	5,356			6,344			10,916
Net charge offs	2,073			1,928			6,466
Provision for loan losses	5,657			417			2,560
Balance at December 31	$	66,037		$	62,453		$	63,964
Ratio of net charge offs during the period to average loans outstanding during the period	0.04		%	0.05		%	0.17		%
Ratio of allowance to non-accrual loans	220.10		%	199.00		%	131.10		%

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

(Dollars in Thousands)	December 31, 2016			December 31, 2015			December 31, 2014
Net charge offs:
Commercial and industrial loans	$	600		$	(302	)	$	865
Agricultural production financing and other farm loans	59			757			970
Real estate loans
Construction	(11		)	101			(509		)
Commercial and farmland	329			(1,209		)	3,820
Residential	511			1,298			633
Home equity	388			1,025			453
Individuals loans for household and other personal expenditures	198			268			280
Lease financing receivables, net of unearned income							(22		)
Other commercial loans	(1		)	(10		)	(24		)
Total net charge offs	$	2,073		$	1,928		$	6,466

40

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 2016, 2015, and 2014 were $5,657,000, $417,000, and $2,560,000, respectively.

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 also takes into consideration identified credit problems, portfolio growth, 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, 2016.  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, 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, 2016, the allowance for loan losses was $66,037,000, an increase of $3,584,000 from December 31, 2015. As a percent of total loans, the allowance decreased to 1.28 percent at December 31, 2016 from 1.33 percent at December 31, 2015.  The decrease in the ratio of allowance to loans was due to a decline in loss rates resulting from the strengthened economy. During 2016, the specific reserves against impaired loans decreased by $954,000, and the allowance for loans not deemed impaired increased by $4,537,000. Not included in the allowance for loan losses is the remaining fair value discount on acquired loans of $34,936,000 and $47,057,000 as of December 31, 2016 and 2015, 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.

41

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table summarizes loan loss reserves by loan segment for the periods ended December 31, 2016 and 2015.

	December 31, 2016
(Dollars in Thousands)	Commercial		Commercial Real Estate		Consumer		Residential		Finance Leases		Total
Allowance balances:
Individually evaluated for impairment	$	37	$	553			$	298			$	888
Collectively evaluated for impairment	27,659		23,108		$	2,923	11,457		$	2	65,149
Loans acquired with deteriorated credit quality
Total allowance for loan losses	$	27,696	$	23,661	$	2,923	$	11,755	$	2	$	66,037

	December 31, 2015
	Commercial		Commercial Real Estate		Consumer		Residential		Finance Leases		Total
Allowance balances:
Individually evaluated for impairment	$	1,277	$	243			$	169			$	1,689
Collectively evaluated for impairment	25,201		21,753		$	2,689	10,966		$	2	60,611
Loans acquired with deteriorated credit quality			149				4				153
Total allowance for loan losses	$	26,478	$	22,145	$	2,689	$	11,139	$	2	$	62,453

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 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.

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 years, 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, 2016 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 at least annually for impairment. The Corporation completed its most recent annual goodwill impairment test on October 1, 2016 and concluded, based on current events and circumstances, goodwill is not impaired. The Ameriana acquisition on December 31, 2015 resulted in $38,624,000 of goodwill, of which, $871,000 was recorded during the first quarter of 2016 as a measurement period adjustment. The C Financial acquisition on April 17, 2015 resulted in goodwill of $11,126,000. On June 12, 2015, the sale of FMIG resulted in a goodwill reduction of $8,474,000. 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.

42

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

LIQUIDITY

Liquidity management is the process by which the Corporation ensures that adequate liquid funds are available for the Corporation 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 is 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$696,862,000 at December 31, 2016, an increase of $38,462,000, or 5.8 percent, from December 31, 2015. 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 $2,046,000 at December 31, 2016. 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, FHLB advances are utilized as a funding source. At December 31, 2016, total borrowings from the FHLB were $298,923,000. The Bank has pledged certain mortgage loans and investments to the FHLB. The total available remaining borrowing capacity from the FHLB at December 31, 2016 was $291,445,000.

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. The line of credit matured on April 8, 2016 and the agreement was not renewed. Interest was payable quarterly based on one-month LIBOR plus 2.00 percent. The line of credit had a quarterly facility fee of 0.25 percent on the unused balance. The line of credit agreement contained certain customary representations and warranties and financial and negative covenants.

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, 2016 are as follows:

	December 31,
(Dollars in Thousands)	2016
Amounts of Commitments:
Loan commitments to extend credit	$	2,057,878
Standby letters of credit	46,010
	$	2,103,888

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, 2016 are as follows:

(Dollars in Thousands)	2017		2018		2019		2020		2021		2021 and after		ASC 805 fair value adjustments at acquisition			Total
Operating leases	$	3,298	$	1,998	$	1,624	$	1,388	$	1,056	$	6,487				$	15,851
Federal funds purchased	120,349															120,349
Securities sold under repurchase agreements	146,480															146,480
Federal Home Loan Bank advances	167,068		26,717		13,828		31,310		25,000		35,000					298,923
Subordinated debentures and term loans	1,018										132,012		$	(4,585	)	128,445
Total	$	438,213	$	28,715	$	15,452	$	32,698	$	26,056	$	173,499	$	(4,585	)	$	710,048

43

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

INTEREST SENSITIVITY AND DISCLOSURES ABOUT MARKET RISK

Asset/Liability management has been an important factor in the Corporation's ability to record consistent earnings growth through periods of interest rate volatility and product deregulation. Management and the Board of Directors monitor the Corporation's liquidity and interest sensitivity positions at regular meetings to 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/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, 2016, 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, 2016.

	December 31, 2016
(Dollars in Thousands)	1-180 Days			181-365 Days			1-5 Years			Beyond 5 Years			Total
Rate-Sensitive Assets:
Interest-bearing deposits	$	24,459											$	24,459
Investment securities	99,969			$	64,197		$	360,605		$	779,734		1,304,505
Loans	2,892,114			298,082			1,043,451			842,890			5,076,537
Federal Reserve and Federal Home Loan Bank stock							17,964						17,964
Total rate-sensitive assets	$	3,016,542		$	362,279		$	1,422,020		$	1,622,624		$	6,423,465
Rate-Sensitive Liabilities:
Interest-bearing deposits	$	3,452,398		$	252,507		$	427,353		$	75,973		$	4,208,231
Federal funds purchased	120,349												120,349
Securities sold under repurchase agreements	146,480												146,480
Federal Home Loan Bank advances	188,511			35,122			50,201			25,089			298,923
Subordinated debentures and term loans	57,427									71,018			128,445
Total rate-sensitive liabilities	$	3,965,165		$	287,629		$	477,554		$	172,080		$	4,902,428
Interest rate sensitivity gap by period	$	(948,623	)	$	74,650		$	944,466		$	1,450,544
Cumulative rate sensitivity gap	$	(948,623	)	$	(873,973	)	$	70,493		$	1,521,037
Cumulative rate sensitivity gap ratio
at December 31, 2016	76.1		%	79.4		%	101.5		%	131.0		%
at December 31, 2015	75.1		%	82.4		%	105.8		%	130.2		%

The Corporation had a cumulative negative gap of $873,973,000 in the one-year horizon at December 31, 2016 or 12.12 percent of total assets. Interest bearing deposits of $3,452,000 includes non-maturity deposits.

44

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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. Historical retention rate assumptions are applied to non-maturity deposits for modeling purposes.

The comparative rising 200 basis points and falling 100 basis points scenarios below, as of December 31, 2016, 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, 2016
	RISING	FALLING
Driver Rates	(200 Basis Points)	(100 Basis Points)
Prime	200	(50)
Federal Funds	200	(50)
One-Year CMT	200	(77)
Three-Year CMT	200	(100)
Five-Year CMT	200	(100)
CD's	200	(16)
FHLB	200	(92)

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, 2016. 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, 2016
			RISING			FALLING
(Dollars in Thousands)	Base		(200 Basis Points)			(100 Basis Points)
Net Interest Income	$	231,074	$	247,920		$	214,302
Variance from Base			$	16,846		$	(16,772	)
Percent of Change from Base			7.29		%	(7.26		)%

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 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, 2015
	RISING	FALLING
Driver Rates	(200 Basis Points)	(100 Basis Points)
Prime	200	(25)
Federal Funds	200	(25)
One-Year CMT	200	(56)
Three-Year CMT	200	(100)
Five-Year CMT	200	(100)
CD's	200	(21)
FHLB	200	(83)

45

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, 2015
			RISING			FALLING
(Dollars in Thousands)	Base		(200 Basis Points)			(100 Basis Points)
Net Interest Income	$	198,711	$	213,758		$	188,921
Variance from Base			$	15,047		$	(9,790	)
Percent of Change from Base			7.57		%	(4.93		)%

EARNING ASSETS

The following table presents the earning asset mix as of December 31, 2016 and 2015. Earnings assets at December 31, 2016 increased by $438,839,000 compared to December 31, 2015. Loans and loans held for sale increased by $438,858,000 while investment securities increased by $27,506,000. The five largest loan segments that experienced increases were commercial and farmland, commercial and industrial, other commercial, home equity and construction. The two loan segments that experienced the largest decreases were residential and agricultural production financing and other loans to farmers. Additional details regarding the changes in the Corporation's loans are discussed within Note 5. LOANS AND ALLOWANCE, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K.

Finally, the decrease in Federal Reserve and Federal Home Loan Bank stock of $19,669,000 was mainly due to the sale of the Corporation's Federal Reserve Bank stock after the conversion to an Indiana state-chartered bank.

	December 31,		December 31,
(Dollars in Thousands)	2016		2015
Interest-bearing time deposits	$	24,459	$	32,315
Investment securities available for sale	696,862		658,400
Investment securities held to maturity	607,643		618,599
Loans held for sale	2,929		9,894
Loans	5,139,645		4,693,822
Federal Reserve and Federal Home Loan Bank stock	17,964		37,633
	$	6,489,502	$	6,050,663

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, 2016 and 2015.

	December 31,		December 31,
(Dollars in Thousands)	2016		2015
Deposits	$	5,556,498	$	5,289,647
Federal funds purchased	120,349		49,721
Securities sold under repurchase agreements	146,480		155,325
Federal Home Loan Bank advances	298,923		235,652
Subordinated debentures and term loans	128,445		127,846
	$	6,250,695	$	5,858,191

Deposits increased $266,851,000 from December 31, 2015. Demand deposits, brokered certificates of deposit and savings deposits increased $290,570,000, $66,904,000 and $42,030,000, respectively, from the same period in 2015. Offsetting these increases were decreases in certificates of deposit of $85,229,000 and certificates of deposit greater than $100,000 of $47,424,000. Federal Funds purchased and Federal Home Loan Bank Advances, which increased $70,628,000 and $63,271,000, respectively, when coupled with the increase in deposits, were used as liquidity sources to support the increase in the loan portfolio.

The Ameriana acquisition on December 31, 2015 and the C Financial acquisition on April 17, 2015 resulted in deposits of $383,718,000 and $105,326,000, respectively. Additionally, the Ameriana and C Financial acquisitions resulted in an addition of approximately $24,884,000 and $18,958,000, respectively, of Federal Home Loan Bank Advances.

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 $5,487,000 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.

46

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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”.

INCOME TAXES

Income tax expense totaled $27,609,000 for 2016 compared to $25,665,000 for 2015.  The Corporation’s federal statutory income tax rate is 35 percent and its state tax rate varies from 0 to 7.75 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 21. 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 decreased from $46,977,000 at December 31, 2015 to $39,384,000 at December 31, 2016. In addition, the Corporation’s net deferred tax asset has decreased from $43,555,000 at December 31, 2015 to $37,755,000 at December 31, 2016.  The $5,800,000 decrease in the Corporation’s net deferred tax asset was due to a combination of a decrease in deferred tax assets offset by a decrease in deferred tax liabilities. The largest deferred tax asset decreases were associated with accounting for loans, other real estate owned, federal net operating loss carryforwards, and pensions and other employee benefits of $3,670,000, $2,592,000, $2,308,000, and $2,164,000, 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 $6,079,000.

The Corporation has recorded a valuation allowance of $9,815,000 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.

47

PART II: ITEM 7. AND ITEM 7A. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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.

48

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, 2016 and 2015, 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, 2016. 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 also 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, 2016, and 2015, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2016, 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, 2016, 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 March, 1, 2017, expressed an unqualified opinion on the effectiveness of the Corporation's internal control over financial reporting.

BKD, LLP

Indianapolis, Indiana

March 1, 2017

49

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEETS

	December 31,			December 31,
(Dollars in Thousands, Except Share Data)	2016			2015
ASSETS
Cash and cash equivalents	$	127,927		$	102,170
Interest-bearing time deposits	24,459			32,315
Investment securities available for sale	696,862			658,400
Investment securities held to maturity (fair value of $611,933 and $632,380)	607,643			618,599
Loans held for sale	2,929			9,894
Loans	5,139,645			4,693,822
Less: Allowance for loan losses	(66,037		)	(62,453		)
Net loans	5,073,608			4,631,369
Premises and equipment	94,432			97,648
Federal Reserve and Federal Home Loan Bank stock	17,964			37,633
Interest receivable	26,194			24,415
Core deposit intangibles	14,866			16,635
Goodwill	244,000			243,129
Cash surrender value of life insurance	201,671			200,539
Other real estate owned	8,966			17,257
Tax asset, deferred and receivable	39,384			46,977
Other assets	30,706			24,023
TOTAL ASSETS	$	7,211,611		$	6,761,003
LIABILITIES
Deposits:
Noninterest-bearing	$	1,348,267		$	1,266,027
Interest-bearing	4,208,231			4,023,620
Total Deposits	5,556,498			5,289,647
Borrowings:
Federal funds purchased	120,349			49,721
Securities sold under repurchase agreements	146,480			155,325
Federal Home Loan Bank advances	298,923			235,652
Subordinated debentures and term loans	128,445			127,846
Total Borrowings	694,197			568,544
Interest payable	3,110			3,092
Other liabilities	56,149			49,211
Total Liabilities	6,309,954			5,910,494
COMMITMENTS AND CONTINGENT LIABILITIES
STOCKHOLDERS' EQUITY
Cumulative Preferred Stock, $1,000 par value, $1,000 liquidation value:
Authorized - 600 shares
Issued and outstanding - 125 shares	125			125
Common Stock, $.125 stated value:
Authorized - 50,000,000 shares
Issued and outstanding - 40,912,697 and 40,664,259 shares	5,114			5,083
Additional paid-in capital	509,018			504,530
Retained earnings	400,981			342,133
Accumulated other comprehensive loss	(13,581		)	(1,362		)
Total Stockholders' Equity	901,657			850,509
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	7,211,611		$	6,761,003

See notes to consolidated financial statements.

50

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF INCOME

	December 31,		December 31,		December 31,
(Dollars in Thousands, Except Share Data)	2016		2015		2014
INTEREST INCOME
Loans receivable:
Taxable	$	210,302	$	180,805	$	172,039
Tax-exempt	6,525		3,459		327
Investment securities:
Taxable	16,415		17,885		19,882
Tax-exempt	18,622		16,922		14,383
Deposits with financial institutions	350		160		124
Federal Reserve and Federal Home Loan Bank stock	1,098		1,967		2,124
Total Interest Income	253,312		221,198		208,879
INTEREST EXPENSE
Deposits	15,914		14,855		11,678
Federal funds purchased	102		74		177
Securities sold under repurchase agreements	374		368		529
Federal Home Loan Bank advances	3,264		2,836		2,842
Subordinated debentures, revolving credit lines and term loans	7,185		6,661		6,616
Total Interest Expense	26,839		24,794		21,842
NET INTEREST INCOME	226,473		196,404		187,037
Provision for loan losses	5,657		417		2,560
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES	220,816		195,987		184,477
OTHER INCOME
Service charges on deposit accounts	17,762		16,201		15,747
Fiduciary activities	9,818		9,196		8,966
Other customer fees	19,315		16,959		15,699
Commission income			4,147		7,411
Earnings on cash surrender value of life insurance	4,273		2,919		3,659
Net gains and fees on sales of loans	7,052		6,483		4,899
Net realized gains on sales of available for sale securities	3,389		2,670		3,581
Gain on sale of insurance subsidiary			8,265
Gain on cancellation of subordinated debentures			1,250
Other income	3,594		1,778		1,854
Total Other Income	65,203		69,868		61,816
OTHER EXPENSES
Salaries and employee benefits	102,552		101,908		96,499
Net occupancy	16,997		14,668		13,831
Equipment	12,497		10,787		9,337
Marketing	3,008		3,493		3,464
Outside data processing fees	9,148		7,109		7,315
Printing and office supplies	1,348		1,353		1,565
Core deposit amortization	3,910		2,835		2,445
FDIC assessments	3,036		3,655		3,738
Other real estate owned and foreclosure expenses	2,877		3,956		3,462
Professional and other outside services	6,516		9,855		8,116
Other expenses	15,470		15,187		14,236
Total Other Expenses	177,359		174,806		164,008
INCOME BEFORE INCOME TAX	108,660		91,049		82,285
Income tax expense	27,609		25,665		22,123
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS	$	81,051	$	65,384	$	60,162
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS PER SHARE:
Basic	$	1.99	$	1.73	$	1.66
Diluted	$	1.98	$	1.72	$	1.65

See notes to consolidated financial statements.

51

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in Thousands)	December 31, 2016			December 31, 2015			December 31, 2014
Net income	$	81,051		$	65,384		$	60,162
Other comprehensive income (loss) net of tax:
Unrealized holding gain (loss) on securities available for sale arising during the period, net of tax of $4,893, $20, and $8,001	(9,087		)	(37		)	14,860
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, $0, and $995							1,847
Unrealized loss on cash flow hedges arising during the period, net of tax of $128, $588, and $1,397	(240		)	(1,093		)	(2,599		)
Reclassification adjustment for net gains included in net income net of tax of $749, $435, and $760	(1,390		)	(808		)	(1,410		)
Defined benefit pension plans, net of tax of  $809, $1,187, and $4,264
Net gain (loss) arising during period	(470		)	2,404			(7,580		)
Amortization of prior service cost	(1,032		)	(198		)	(338		)
	(12,219		)	268			4,780
Comprehensive income	$	68,832		$	65,652		$	64,942

See notes to consolidated financial statements.

52

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

	Preferred			Common Stock
(Dollars in Thousands, Except Share Data)	Shares	Amount		Shares		Amount			Additional Paid in Capital			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total
Balances, December 31, 2013	125	$	125	35,921,761		$	4,490		$	393,783		$	242,935		$	(6,410	)	$	634,923
Comprehensive income
Net income												60,162						60,162
Other comprehensive income (loss), net of tax															4,780			4,780
Cash dividends on common stock ($.29 per share)												(10,694		)				(10,694		)
Issuance of common stock related to acquisition				1,574,298		197			34,784									34,981
Share-based compensation				132,446		17			2,160									2,177
Stock issued under employee benefit plans				26,547		3			475									478
Stock issued under dividend reinvestment and stock purchase plan				24,556		3			520									523
Stock options exercised				41,249		5			559									564
Stock redeemed				(50,909	)	(6		)	(1,061		)							(1,067		)
Balances, December 31, 2014	125	$	125	37,669,948		$	4,709		$	431,220		$	292,403		$	(1,630	)	$	726,827
Comprehensive income
Net income												65,384						65,384
Other comprehensive income (loss), net of tax															268			268
Cash dividends on common stock ($.41 per share)												(15,654		)				(15,654		)
Issuance of common stock related to acquisition				2,769,568		346			70,056									70,402
Share-based compensation				149,577		19			2,251									2,270
Stock issued under employee benefit plans				22,074		3			457									460
Stock issued under dividend reinvestment and stock purchase plan				26,375		3			658									661
Stock options exercised				96,066		12			1,519									1,531
Stock redeemed				(69,349	)	(9		)	(1,631		)							(1,640		)
Balances, December 31, 2015	125	$	125	40,664,259		$	5,083		$	504,530		$	342,133		$	(1,362	)	$	850,509
Comprehensive income
Net income												81,051						81,051
Other comprehensive income (loss), net of tax															(12,219		)	(12,219		)
Cash dividends on common stock ($.54 per share)												(22,203		)				(22,203		)
Share-based compensation				141,126		17			2,583									2,600
Stock issued under employee benefit plans				20,545		3			459									462
Stock issued under dividend reinvestment and stock purchase plan				30,297		4			831									835
Stock options exercised				128,848		16			2,586									2,602
Stock redeemed				(72,378	)	(9		)	(1,971		)							(1,980		)
Balances, December 31, 2016	125	$	125	40,912,697		$	5,114		$	509,018		$	400,981		$	(13,581	)	$	901,657

See notes to consolidated financial statements.

53

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF CASH FLOWS

	December 31,			December 31,			December 31,
(Dollars in Thousands)	2016			2015			2014
Cash Flow From Operating Activities:
Net income	$	81,051		$	65,384		$	60,162
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses	5,657			417			2,560
Depreciation and amortization	7,161			6,262			6,007
Change in deferred taxes	8,611			4,444			15,048
Share-based compensation	2,600			2,270			2,177
Tax benefit from stock options exercised	(107		)	(70		)	(60		)
Loans originated for sale	(354,265		)	(364,411		)	(222,892		)
Proceeds from sales of Loans	367,148			367,377			225,158
Gains on sales of loans held for sale	(5,918		)	(5,625		)	(4,170		)
Gain on sale of insurance subsidiary				(8,265		)
Gain on cancellation of subordinated debentures				(1,250		)
Gains on sales of securities available for sale	(3,389		)	(2,670		)	(3,581		)
Change in interest receivable	(1,779		)	(2,833		)	(545		)
Change in interest payable	18			(162		)	1,332
Other adjustments	72			(4,208		)	(5,356		)
Net cash provided by operating activities	106,860			56,660			75,840
Cash Flows from Investing Activities:
Net change in interest-bearing deposits	7,856			24,917			24,075
Purchases of:
Securities available for sale	(281,470		)	(200,154		)	(110,936		)
Securities held to maturity	(110,797		)	(87,282		)	(142,988		)
Proceeds from sales of securities available for sale	167,186			83,647			126,575
Proceeds from maturities of:
Securities available for sale	73,956			63,124			68,339
Securities held to maturity	119,052			98,581			69,420
Redemption (Purchase) of Federal Reserve and Federal Home Loan Bank stock	19,669			7,268			(413		)
Net change in loans	(452,781		)	(350,287		)	(170,109		)
Net cash and cash equivalents received (paid) in acquisition				(7,936		)	(10,084		)
Net cash received from sale of insurance subsidiary				15,155
Proceeds from the sale of other real estate owned	9,974			12,567			14,241
Other investing activities	(4,490		)	9			5,889
Net cash used in investing activities	(451,845		)	(340,391		)	(125,991		)
Cash Flows from Financing Activities:
Net change in :
Demand and savings deposits	332,600			240,736			53,062
Certificates of deposit and other time deposits	(66,920		)	(79,656		)	127,740
Borrowings	1,107,795			491,660			678,290
Repayment of borrowings	(982,449		)	(370,813		)	(789,563		)
Cash dividends on common stock	(22,203		)	(15,654		)	(10,694		)
Stock issued under employee benefit plans	462			460			478
Stock issued under dividend reinvestment and stock purchase plans	835			661			523
Stock options exercised	2,495			1,461			504
Tax benefit from stock options exercised	107			70			60
Stock redeemed	(1,980		)	(1,640		)	(1,067		)
Net cash provided by financing activities	370,742			267,285			59,333
Net Change in Cash and Cash Equivalents	25,757			(16,446		)	9,182
Cash and Cash Equivalents, January 1	102,170			118,616			109,434
Cash and Cash Equivalents, December 31	$	127,927		$	102,170		$	118,616
Additional cash flow information:
Interest paid	$	26,821		$	24,903		$	20,412
Income tax paid	11,999			21,200			6,209
Loans transferred to other real estate owned	1,684			3,644			4,431
Fixed assets transferred to other real estate owned	360			1,600			297
Non-cash investing activities using trade date accounting	14,179			1,559			3,170

CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED

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

	December 31, 2016		December 31, 2015			December 31, 2014
Fair value of assets acquired	$	—	$	635,047		$	280,725
Cash received (paid) in acquisition			(14,500		)	(14,208		)
Less: Common stock issued			70,402			34,981
Liabilities assumed	$	—	$	550,145		$	231,536

See notes to consolidated financial statements.

54

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 1

NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting and reporting policies of the Corporation and the Bank, conform to accounting principles generally accepted in the United States of America and reporting practices followed by the banking industry.

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 provides full banking services under an Indiana state-charter. On April 1, 2016, the Board of Directors of the Bank adopted final resolutions approving the conversion of the Bank’s banking charter from a national association to an Indiana state-chartered bank. The initial application to convert was filed with the Indiana DFI on February 9, 2016. Between the date of initial application and adoption of the final resolutions by the Bank’s Board, the Indiana DFI and the FDIC conducted a joint exam of the Bank and its banking activities. Final regulatory approval of the application was obtained at the meeting of the Members of the Indiana DFI on April 14, 2016. The Bank filed official conversion documents effective April 15, 2016. As a result of the conversion, the Indiana DFI became the Bank’s primary regulator and the FDIC became the Bank’s primary federal regulator. Upon conversion, the Bank’s official name changed from “First Merchants Bank, National Association” to “First Merchants Bank.” The Bank continues operating under the following trade names in certain geographic markets: Lafayette Bank and Trust and First Merchants Private Wealth Advisors (each as a division of First Merchants Bank). The conversion is not expected to affect the Bank’s operations or customers in any way, and Bank customers will continue to receive identical protection on deposits through the FDIC’s deposit insurance program.

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 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 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.

55

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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, substantially delinquent and renegotiated loans classified as troubled debt restructures may be considered to be impaired in accordance with ASC 310. Under ASC 310, 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. Renegotiated consumer loans classified as troubled debt restructures are considered to be impaired. In applying the provisions of ASC 310, the Corporation considers all other investments 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. The accrual of interest is discontinued on a loan when, in management’s opinion, the borrower may be unable to meet payments as they become due. When the 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 fair value of collateral if the loan is collateral dependent, or the present value of estimated future cash flows using the loan’s existing rate. 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 purchased 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 individually evaluated 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 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. Acquired loans not accounted for under ASC 310-30 are accounted for under ASC 310-20, which allows the fair value adjustment to be accreted into income over the remaining life of the loans.

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 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 regional geographic and industry levels, 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 impaired loans accounted for under ASC 310, 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.

Commercial relationships greater than $500,000 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 fair value of the underlying collateral if collateral dependent or the present value of expected future cash flows discounted at the loan’s effective interest rate. The Corporation evaluates the collectability of principal when assessing the need for a loss accrual. Historical loss rates are applied to other commercial loans not subject to specific reserve allocations.

56

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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 20. 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 HOME LOAN BANK STOCK is a required investment for institutions that are members of the FHLB. The Bank is a member of the FHLB of Indianapolis. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is 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 other real estate owned and foreclosure expenses. 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 AOCI 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.

57

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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 AOCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in AOCI 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 in the consolidated statements of income. 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 is generally no longer subject to U.S. federal, state and local income tax examinations by tax authorities for tax years before 2013.

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 Corporation's policy is to recognize interest and penalties related to unrecognized tax benefits, if any, as a component of income tax expense.

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.

58

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 2

ACQUISITIONS AND DIVESTITURES

Ameriana Bancorp, Inc.

On December 31, 2015, the Corporation acquired 100 percent of 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, an Indiana Bank and wholly-owned subsidiary of Ameriana, merged with and into 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 to income 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 were expected. The purchase price of the Ameriana acquisition was allocated as follows:

	Fair Value
Cash and cash equivalents	$	4,068
Interest-bearing time deposits	8,790
Investment securities	61,754
Loans	316,929
Premises and equipment	13,946
Federal Home Loan Bank stock	2,693
Other real estate owned	5,613
Interest receivable	1,306
Cash surrender value of life insurance	28,188
Other assets	6,713
Deposits	(383,718		)
Interest payable	(24		)
Federal Home Loan Bank Advances	(24,884		)
Subordinated Debentures	(5,487		)
Other liabilities	(9,451		)
Net tangible assets acquired	26,436
Core deposit intangible	5,342
Goodwill	38,624
Purchase price	$	70,402

Of the total purchase price, $5,342,000 has been allocated to a core deposit intangible that will be amortized over its estimated life of 10 years. The remaining purchase price has been allocated to goodwill, which is not deductible for tax purposes.

59

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

C Financial Corporation

On April 17, 2015, the Corporation acquired 100 percent of 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 engaged in this transaction with the expectation that it would 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 were expected. The purchase price of the C Financial acquisition was allocated as follows:

	Fair Value
Cash and cash equivalents	$	2,496
Federal Funds sold	7,018
Interest-bearing time deposits	922
Loans	110,625
Premises and equipment	7,290
Federal Home Loan Bank stock	855
Interest receivable	292
Other assets	119
Deposits	(105,326		)
Interest payable	(29		)
Federal Home Loan Bank Advances	(18,958		)
Other liabilities	(2,911		)
Net tangible assets acquired	2,393
Core deposit intangible	981
Goodwill	11,126
Purchase 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 remaining purchase price has been allocated to goodwill, which is deductible over a 15 year period for tax purposes as this transaction was considered a taxable exchange.

Community Bancshares, Inc.

On November 7, 2014, the Corporation acquired 100 percent of 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. The Corporation engaged in this transaction with the expectation that it would be accretive to income and expand the existing footprint in central Indiana. Goodwill resulted from this transaction due to the expected synergies and economies of scale that were expected. The purchase price of the Community acquisition was allocated as follows:

	Fair Value
Cash and cash equivalents	$	4,124
Interest -bearing time deposits	16,526
Investment Securities, available for sale	76,807
Loans	145,064
Premises and equipment	3,610
Federal Home Loan Bank stock	1,950
Interest Receivable	767
Cash surrender value of life insurance	3,266
Other real estate owned	6,662
Taxes, deferred and receivable	3,348
Other assets	167
Deposits	(228,424		)
Interest payable	(98		)
Other liabilities	(3,014		)
Net tangible assets acquired	$	30,755
Core deposit intangible	4,658
Goodwill	13,776
Purchase price	$	49,189

60

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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 remaining 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 FMIG to 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 Ameriana, C Financial and Community 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 and 2014 as if the Ameriana and Community 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.

	2015		2014
Total revenue (net interest income plus other income)	$	291,614	$	284,890
Net income	$	60,497	$	64,174
Net income available to common shareholders	$	60,497	$	64,174
Earnings per share:
Basic	$	1.49	$	1.58
Diluted	$	1.48	$	1.57

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 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, 2016, cash and cash equivalents is defined to include cash on hand, deposits in other institutions and federal funds sold.

On July 21, 2010, the Dodd-Frank Act was signed into law, which, in part, permanently raised the standard maximum deposit insurance amount to $250,000.  

At December 31, 2016, the Corporation’s interest-bearing cash accounts and noninterest-bearing transaction deposits held at other institutions exceeded federally insured limits by approximately $87,431,000. 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 $5,969,000 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, 2016, was $24,153,000.

61

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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 Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Available for sale at December 31, 2016
U.S. Government-sponsored agency securities	$	100					$	100
State and municipal	360,779		$	8,443	$	5,564	363,658
U.S. Government-sponsored mortgage-backed securities	313,459		1,904		3,071		312,292
Corporate obligations	31						31
Equity securities	21,820				1,039		20,781
Total available for sale	696,189		10,347		9,674		696,862
Held to maturity at December 31, 2016
U.S. Government-sponsored agency securities	22,619				479		22,140
State and municipal	224,811		3,136		1,796		226,151
U.S. Government-sponsored mortgage-backed securities	360,213		4,956		1,527		363,642
Total held to maturity	607,643		8,092		3,802		611,933
Total Investment Securities	$	1,303,832	$	18,439	$	13,476	$	1,308,795
Available for sale at December 31, 2015
U.S. Government-sponsored agency securities	$	100	$	4			$	104
State and municipal	291,730		14,241		$	60	305,911
U.S. Government-sponsored mortgage-backed securities	342,550		4,234		518		346,266
Corporate obligations	31						31
Equity securities	3,912						3,912
Certificates of deposit	2,176						2,176
Total available for sale	640,499		18,479		578		658,400
Held to maturity at December 31, 2015
State and municipal	219,767		6,982		15		226,734
U.S. Government-sponsored mortgage-backed securities	398,832		7,601		787		405,646
Total held to maturity	618,599		14,583		802		632,380
Total Investment Securities	$	1,259,098	$	33,062	$	1,380	$	1,290,780

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 $523,773,000 and $178,964,000 at December 31, 2016 and 2015, respectively.  Total fair value of these investments was $510,297,000  and $177,584,000, which was approximately 39.1 and 13.9 percent of the Corporation's available for sale and held to maturity investment portfolio at December 31, 2016 and 2015, 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 OTTI is identified.

The Corporation’s management has evaluated all securities with unrealized losses for OTTI as of December 31, 2016.  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.

62

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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, 2016. As noted in the table above, the mortgage-backed securities portfolio contains unrealized losses of $3,071,000 on forty-six securities and $1,527,000 on twenty-nine 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, 2016. As noted in the table above, the state and political subdivision securities portfolio contains unrealized losses of $5,564,000 on one hundred eight securities and $1,796,000 on seventy-one securities in the available for sale and held to maturity portfolios, respectively.

U.S. Government-Sponsored Agency Securities

The unrealized losses on the Corporation's investment in U.S. Government-Sponsored Agency securities were a result of interest rate changes. 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, 2016. As noted in the table above, the U.S. Government-Sponsored Agency securities portfolio contains no unrealized losses in the available for sale portfolio, and $479,000 on four securities in the held to maturity portfolio.

Equity Securities

The unrealized losses on the Corporation's investment in Equity securities were a result of fluctuations in the stock market. 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, the Corporation does not consider those investments to be other-than-temporarily impaired at December 31, 2016. As noted in the table above, the Equity securities portfolio contains unrealized losses of $1,039,000 on one security in the available for sale portfolio, and no unrealized losses in the held to maturity portfolio.

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 in		Accumulated Credit Losses in
	2016		2015
Credit losses on debt securities held:
Balance, January 1	$	—	$	500
Reductions for previous other-than-temporary losses realized on securities sold during the year	—		$	(500	)
Balance, December 31	$	—	$	—

63

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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, 2016 and 2015: 

	Less than 12 Months				12 Months or Longer				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
Temporarily Impaired Available for Sale Securities at December 31, 2016
State and municipal	$	126,593	$	5,564					$	126,593	$	5,564
U.S. Government-sponsored mortgage-backed securities	185,544		3,071						185,544		3,071
Equity securities	18,765		1,039						18,765		1,039
Total Temporarily Impaired Available for Sale Securities	330,902		9,674						330,902		9,674
Temporarily Impaired Held to Maturity Securities at December 31, 2016
U.S. Government-sponsored agency securities	19,121		479						19,121		479
State and municipal	50,897		1,796						50,897		1,796
U.S. Government-sponsored mortgage-backed securities	109,377		1,527						109,377		1,527
Total Temporarily Impaired Held to Maturity Securities	179,395		3,802						179,395		3,802
Total Temporarily Impaired Investment Securities	$	510,297	$	13,476					$	510,297	$	13,476
	Less than 12 Months				12 Months or Longer				Total
	Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Gross Unrealized Losses
Temporarily Impaired Available for Sale Securities at December 31, 2015
State and municipal	$	7,558	$	60					$	7,558	$	60
U.S. Government-sponsored mortgage-backed securities	83,396		445		$	2,101	$	73	85,497		518
Total Temporarily Impaired Available for Sale Securities	90,954		505		2,101		73		93,055		578
Temporarily Impaired Held to Maturity Securities at December 31, 2015
State and municipal					1,982		15		1,982		15
U.S. Government-sponsored mortgage-backed securities	69,641		519		12,906		268		82,547		787
Total Temporarily Impaired Held to Maturity Securities	69,641		519		14,888		283		84,529		802
Total Temporarily Impaired Investment Securities	$	160,595	$	1,024	$	16,989	$	356	$	177,584	$	1,380

The amortized cost and fair value of securities available for sale and held to maturity at December 31, 2016 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 Sale				Held to Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Maturity Distribution at December 31, 2016
Due in one year or less	$	2,703	$	2,717	$	2,046	$	2,047
Due after one through five years	16,359		17,068		61,921		63,193
Due after five through ten years	60,614		62,241		61,606		61,145
Due after ten years	281,234		281,763		121,857		121,906
	360,910		363,789		247,430		248,291
U.S. Government-sponsored mortgage-backed securities	313,459		312,292		360,213		363,642
Equity securities	21,820		20,781
Total Investment Securities	$	696,189	$	696,862	$	607,643	$	611,933

Securities with a carrying value of approximately $572,896,000, $637,358,000 and $449,408,000  were pledged at December 31, 2016, 2015 and 2014, respectively, to secure certain deposits and securities sold under repurchase agreements, and for other purposes as permitted or required by law.

The book value of securities sold under agreements to repurchase amounted to $145,936,000 at December 31, 2016, and $153,789,000 at

December 31, 2015.

Gross gains of $3,389,000, $2,770,000 and $3,581,000 were realized on sales of investment securities in 2016, 2015 and 2014, 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 2016 or 2014.

64

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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, 2016 and 2015, were $2,929,000 and $9,894,000, respectively.

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

	December 31, 2016			December 31, 2015
Commercial and industrial loans	$	1,194,646		$	1,057,075
Agricultural production financing and other loans to farmers	79,689			97,711
Real estate loans:
Construction	418,703			366,704
Commercial and farmland	1,953,062			1,802,921
Residential	739,169			786,105
Home equity	418,525			348,613
Individuals' loans for household and other personal expenditures	77,479			74,717
Lease financing receivables, net of unearned income	311			588
Other commercial loans	258,061			159,388
Loans	5,139,645			4,693,822
Allowance for loan losses	(66,037		)	(62,453		)
Net Loans	$	5,073,608		$	4,631,369

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, 2016.  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 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 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.

65

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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, 2016, the allowance for loan losses was $66,037,000, an increase of $3,584,000 from the December 31, 2015 balance of $62,453,000. Net charge offs for the twelve months ended December 31, 2016, were $2,073,000, an increase of $145,000 from the same period in 2015. The provision for loan losses for the twelve months ended December 31, 2016 was $5,657,000, an increase of $5,240,000 from the same period in 2015. 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 following tables summarize changes in the allowance for loan losses by loan segment for the twelve months ended December 31, 2016, 2015 and 2014:

	Twelve Months Ended December 31, 2016
	Commercial			Commercial Real Estate			Consumer			Residential			Finance Leases		Total
Allowance for loan losses:
Balances, December 31, 2015	$	26,478		$	22,145		$	2,689		$	11,139		$	2	$	62,453
Provision for losses	1,876			1,834			432			1,515					5,657
Recoveries on loans	1,806			2,090			369			1,091					5,356
Loans charged off	(2,464		)	(2,408		)	(567		)	(1,990		)			(7,429		)
Balances, December 31, 2016	$	27,696		$	23,661		$	2,923		$	11,755		$	2	$	66,037

	Twelve Months Ended December 31, 2015
	Commercial			Commercial Real Estate			Consumer			Residential			Finance Leases			Total
Allowance for loan losses:
Balances, December 31, 2014	$	28,824		$	19,327		$	2,658		$	13,152		$	3		$	63,964
Provision for losses	(1,901		)	1,710			299			310			(1		)	417
Recoveries on loans	1,911			2,545			352			1,536						6,344
Loans 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, 2014
	Commercial			Commercial Real Estate			Consumer			Residential			Finance Leases			Total
Allowance for loan losses:
Balances, December 31, 2013	$	27,176		$	23,102		$	2,515		$	15,077					$	67,870
Provision for losses	3,459			(464		)	423			(839		)	$	(19	)	2,560
Recoveries on loans	5,435			3,297			377			1,783			24			10,916
Loans 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

66

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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

	December 31, 2016
	Commercial		Commercial Real Estate		Consumer		Residential		Finance Leases		Total
Allowance balances:
Individually evaluated for impairment	$	37	$	553			$	298			$	888
Collectively evaluated for impairment	27,659		23,108		$	2,923	11,457		$	2	65,149
Loans acquired with deteriorated credit quality
Total Allowance for Loan Losses	$	27,696	$	23,661	$	2,923	$	11,755	$	2	$	66,037
Loan balances:
Individually evaluated for impairment	$	4,762	$	21,358	9		$	4,450			$	30,579
Collectively evaluated for impairment	1,520,981		2,315,686		$	77,470	1,151,396		$	311	5,065,844
Loans acquired with deteriorated credit quality	6,653		34,721				1,848				43,222
Loans	$	1,532,396	$	2,371,765	$	77,479	$	1,157,694	$	311	$	5,139,645

	December 31, 2015
	Commercial		Commercial Real Estate		Consumer		Residential		Finance Leases		Total
Allowance balances:
Individually evaluated for impairment	$	1,277	$	243			$	169			$	1,689
Collectively evaluated for impairment	25,201		21,753		$	2,689	10,966		$	2	60,611
Loans acquired with deteriorated credit quality			149				4				153
Total Allowance for Loan Losses	$	26,478	$	22,145	$	2,689	$	11,139	$	2	$	62,453
Loan balances:
Individually evaluated for impairment	$	7,877	$	16,670			$	4,020			$	28,567
Collectively evaluated for impairment	1,298,988		2,096,089		$	74,717	1,125,316		$	588	4,595,698
Loans acquired with deteriorated credit quality	7,309		56,866				5,382				69,557
Loans	$	1,314,174	$	2,169,625	$	74,717	$	1,134,718	$	588	$	4,693,822

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.

Consumer and Residential

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. When the interest accrual is discontinued, all unpaid accrued interest is reversed against earnings when considered uncollectable. 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.

67

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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

	December 31, 2016		December 31, 2015
Commercial and industrial loans	$	1,839	$	4,634
Agriculture production financing and other loans to farmers	1,329		827
Real estate loans:
Construction	73		736
Commercial and farmland	15,754		11,277
Residential	9,523		11,818
Home equity	1,457		1,952
Individuals' loans for household and other personal expenditures	23		145
Total	$	29,998	$	31,389

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 may require 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 andor 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.

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

	December 31, 2016
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans with no related allowance:
Commercial and industrial loans	$	17,645	$	10,074			$	13,393	$	499
Agriculture production financing and other loans to farmers	757		680				750		3
Real estate loans:
Construction	5,946		3,178				3,255		258
Commercial and farmland	67,936		49,731				51,740		2,978
Residential	8,039		4,664				5,410		167
Home equity	82		44				44
Other commercial loans	11
Total	$	100,416	$	68,371			$	74,592	$	3,905
Impaired loans with related allowance:
Agriculture production financing and other loans to farmers	$	660	$	660	$	36	$	691
Real estate loans:
Commercial and farmland	4,238		2,985		553		2,989
Residential	65		34		23		38
Total	$	4,963	$	3,679	$	612	$	3,718
Total Impaired Loans	$	105,379	$	72,050	$	612	$	78,310	$	3,905

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

	December 31, 2015
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans with no related allowance:
Commercial and industrial loans	$	22,151	$	11,669			$	12,578	$	488
Agriculture production financing and other loans to farmers	370		361				439
Real estate loans:
Construction	4,551		2,336				3,662		157
Commercial and farmland	95,930		69,024				71,569		3,328
Residential	11,262		7,338				7,926		244
Home equity	297		247				249
Other commercial loans	20
Total	$	134,581	$	90,975			$	96,423	$	4,217
Impaired loans with related allowance:
Commercial and industrial loans	$	3,043	$	2,690	$	1,247	$	2,752	$	38
Agriculture production financing and other loans to farmers	466		466		30		538
Real estate loans:
Commercial and farmland	2,144		1,933		392		1,868
Residential	2,300		1,463		173		1,787
Total	$	7,953	$	6,552	$	1,842	$	6,945	$	38
Total Impaired Loans	$	142,534	$	97,527	$	1,842	$	103,368	$	4,255

	December 31, 2014
	Unpaid Principal Balance		Recorded Investment		Related Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans with no related allowance:
Commercial and industrial loans	$	35,514	$	18,029			$	18,711	$	362
Agriculture production financing and other loans to farmers	26		22				26
Real estate loans:
Construction	12,956		9,318				9,837		427
Commercial and farmland	95,856		68,187				70,844		3,389
Residential	10,591		6,839				6,987		119
Home equity	3,590		398				402
Other commercial loans	30
Total	$	158,563	$	102,793			$	106,807	$	4,297
Impaired loans with related allowance:
Commercial and industrial loans	$	1,766	$	1,684	$	1,055	$	1,721	$	40
Agriculture production financing and other loans to farmers	6,777		5,777		400		8,044		1
Real estate loans:
Commercial and farmland	7,159		4,971		1,120		4,999		24
Residential	1,001		998		194		1,000
Total	$	16,703	$	13,430	$	2,769	$	15,764	$	65
Total Impaired Loans	$	175,266	$	116,223	$	2,769	$	122,571	$	4,362

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.

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.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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:

o the 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,

o the 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,

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

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

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

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

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

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

o there 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 or 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.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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, 2016
	Commercial Pass		Commercial Special Mention		Commercial Substandard		Commercial Doubtful	Commercial Loss	Consumer Performing		Consumer Non Performing		Total
Commercial and industrial loans	$	1,117,545	$	30,919	$	46,182							$	1,194,646
Agriculture production financing and other loans to farmers	30,712		25,273		23,704								79,689
Real estate loans:
Construction	398,646		3,490		1,858				$	14,636	$	73	418,703
Commercial and farmland	1,811,367		60,028		80,626				1,034		7		1,953,062
Residential	146,251		5,106		6,046				574,054		7,712		739,169
Home equity	7,310		47		516				409,237		1,415		418,525
Individuals' loans for household and other personal expenditures									77,456		23		77,479
Lease financing receivables, net of unearned income	228				83								311
Other commercial loans	257,861				200								258,061
Loans	$	3,769,920	$	124,863	$	159,215			$	1,076,417	$	9,230	$	5,139,645

	December 31, 2015
	Commercial Pass		Commercial Special Mention		Commercial Substandard		Commercial Doubtful		Commercial Loss	Consumer Performing		Consumer Non Performing		Total
Commercial and industrial loans	$	962,340	$	48,432	$	45,984	$	319						$	1,057,075
Agriculture production financing and other loans to farmers	77,884		6,665		13,162									97,711
Real estate loans:
Construction	345,449		1,271		1,790					$	18,114	$	80	366,704
Commercial and farmland	1,679,141		46,442		77,338									1,802,921
Residential	171,576		3,107		10,428					593,533		7,461		786,105
Home equity	8,218		48		600					337,718		2,029		348,613
Individuals' loans for household and other personal expenditures										74,491		226		74,717
Lease financing receivables, net of unearned income	495				93									588
Other commercial loans	159,388													159,388
Loans	$	3,404,491	$	105,965	$	149,395	$	319		$	1,023,856	$	9,796	$	4,693,822

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

The tables below show a past due aging of the Corporation’s loan portfolio, by loan class, for the years indicated:

	December 31, 2016
	Current		30-59 Days Past Due		60-89 Days Past Due		Loans > 90 Days And Accruing		Non-Accrual		Total Past Due & Non-Accrual		Total
Commercial and industrial loans	$	1,192,079	$	466	$	162	$	100	$	1,839	$	2,567	$	1,194,646
Agriculture production financing and other loans to farmers	78,360								1,329		1,329		79,689
Real estate loans:
Construction	415,975		2,655						73		2,728		418,703
Commercial and farmland	1,932,896		1,385		3,027				15,754		20,166		1,953,062
Residential	725,338		3,664		635		9		9,523		13,831		739,169
Home equity	415,969		850		246		3		1,457		2,556		418,525
Individuals' loans for household and other personal expenditures	76,929		470		57				23		550		77,479
Lease financing receivables, net of unearned income	311												311
Other commercial loans	258,061												258,061
Loans	$	5,095,918	$	9,490	$	4,127	$	112	$	29,998	$	43,727	$	5,139,645

	December 31, 2015
	Current		30-59 Days Past Due		60-89 Days Past Due		Loans > 90 Days And Accruing		Non-Accrual		Total Past Due & Non-Accrual		Total
Commercial and industrial loans	$	1,052,275	$	166					$	4,634	$	4,800	$	1,057,075
Agriculture production financing and other loans to farmers	96,884								827		827		97,711
Real estate loans:
Construction	362,084		3,884						736		4,620		366,704
Commercial and farmland	1,786,092		5,552						11,277		16,829		1,802,921
Residential	765,634		6,090		$	2,061	$	502	11,818		20,471		786,105
Home equity	344,344		1,433		560		324		1,952		4,269		348,613
Individuals' loans for household and other personal expenditures	73,990		445		56		81		145		727		74,717
Lease financing receivables, net of unearned income	588												588
Other commercial loans	159,324				64						64		159,388
Loans	$	4,641,215	$	17,570	$	2,741	$	907	$	31,389	$	52,607	$	4,693,822

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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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

The following tables summarize troubled debt restructurings in the Corporation's loan portfolio that occurred during the periods ended December 31, 2016 and 2015:

	December 31, 2016
	Pre-Modification Recorded Balance		Post-Modification Recorded Balance		Number of Loans
Commercial and industrial loans	$	410	$	410	4
Agriculture production financing and other loans to farmers	1,368		1,234		4
Real estate loans:
Commercial and farmland	3,978		3,954		7
Residential	1,126		1,183		17
Home Equity	266		244		4
Individuals' loans for household and other personal expenditures	17		10		1
Total	$	7,165	$	7,035	37

	December 31, 2015
	Pre-Modification Recorded Balance		Post-Modification Recorded Balance		Number of Loans
Commercial and industrial loans	$	4,111	$	2,115	7
Real estate loans:
Construction	79		80		1
Commercial and farmland	1,281		3,024		3
Residential	200		1,113		10
Home equity	263		242		1
Individuals' loans for household and other personal expenditures	26		27		1
Total	$	5,960	$	6,601	23

The following tables summarize the recorded investment of troubled debt restructurings as of December 31, 2016 and 2015, by modification type, that occurred during the periods indicated:

	December 31, 2016
	Term Modification		Rate Modification		Combination		Total Modification
Commercial and industrial loans					$	397	$	397
Agriculture production financing and other farm loans	$	660	$	12			672
Real estate loans:
Commercial and farmland	297				3,456		3,753
Residential	238		928				1,166
Home equity			266				266
Individuals' loans for household and other personal expenditures			9				9
Total	$	1,195	$	1,215	$	3,853	$	6,263

	December 31, 2015
	Term Modification		Rate Modification		Combination		Total Modification
Commercial and industrial loans	$	761			$	1,053	$	1,814
Real estate loans:
Commercial and farmland	1,231				1,026		2,257
Residential	823		$	170	45		1,038
Home equity			242				242
Individuals' loans for household and other personal expenditures			27				27
Total	$	2,815	$	439	$	2,124	$	5,378

73

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

Loans secured by commercial and farmland real estate made up 56 percent of the post-modification balances of the troubled debt restructured loans that occurred during the twelve months ending December 31, 2016.

The following tables summarize troubled debt restructures that occurred during the twelve months ended December 31, 2016 and 2015, 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, 2016
	Number of Loans	Recorded Balance
Commercial and industrial loans	3	$	197
Agriculture production financing and other loans to farmers	1	661
Real estate loans:
Commercial and farmland	1	343
Residential	1	64
Total	6	$	1,265

	Twelve Months Ended December 31, 2015
	Number of Loans	Recorded Balance
Real estate loans:
Residential	1	$	21
Total	1	$	21

For potential consumer loan restructures, impairment evaluation occurs prior to modification. Any subsequent impairment is typically addressed through the charge off process or a specific reserve in the allowance for loan and lease losses. Consumer troubled debt restructurings are included in the general historical allowance for loan loss at the post modification balance if a specific reserve is not established. Consumer non-accrual and delinquent troubled debt restructurings are also considered in the calculation of the non-accrual and delinquency trend environmental allowance allocation. Consumer mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process totaled $1,530,000 and $1,391,000 at December 31, 2016 and 2015, respectively.

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 fair value adjustment to be accreted into income over the remaining life of the loans.

The Corporation's recent acquisitions are detailed in Note 2, ACQUISTIONS AND DIVESTITURES, in the Notes to Consolidated Financial Statements included as Item 8 of this Annual Report on Form 10-K. In addition, the Corporation acquired CFS in November 2013 and certain loans from SCB in February 2012.

The information presented in this Note 6 reflects actual amounts resulting from the December 31, 2015 Ameriana transaction; whereas estimates were reported in Note 6 ACCOUNTING FOR CERTAIN LOANS ACQUIRED IN A PURCHASE, in the Notes to Consolidated Financial Statements included as Item 8 of the December 31, 2015 Annual Report on Form 10-K.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

The following tables include the outstanding balance and carrying amount of all acquired loans which are included in the Corporation's balance sheet at December 31, 2016 and December 31, 2015.

	December 31, 2016
	Ameriana		C Financial		Community		CFS		SCB		Total
Outstanding Balance:
Commercial and industrial loans	$	8,003	$	85	$	2,269	$	23,327	$	3,552	$	37,236
Agricultural production financing and other loans to farmers					1,030		50		1,630		2,710
Real estate loans:
Construction	22,017		2,835		4,026		420				29,298
Commercial and farmland	103,075		22,130		36,947		131,895		9,315		303,362
Residential	103,414		44,101		9,363		96,627		4,135		257,640
Home Equity	11,728		7,947		6,326		26,894		11,924		64,819
Individuals' loans for household and other personal expenditures	762		2		147		201		30		1,142
Other commercial loans	1,825						65				1,890
Total	$	250,824	$	77,100	$	60,108	$	279,479	$	30,586	$	698,097
Carrying Amount	$	240,053	$	75,194	$	56,007	$	266,845	$	27,318	$	665,417
Allowance	265				23		92				380
Carrying Amount Net of Allowance	$	239,788	$	75,194	$	55,984	$	266,753	$	27,318	$	665,037

	December 31, 2015
	Ameriana		C Financial		Community		CFS		SCB		Total
Outstanding Balance:
Commercial and industrial loans	$	21,888	$	104	$	6,769	$	52,060	$	4,620	$	85,441
Agricultural production financing and other loans to farmers					1,761				1,288		3,049
Real estate loans:
Construction	23,365		6,214		10,436		976				40,991
Commercial and farmland	144,514		27,838		49,997		189,372		13,293		425,014
Residential	123,231		55,856		21,886		118,105		6,063		325,141
Home Equity	14,261		9,144		8,231		31,986		13,431		77,053
Individuals' loans for household and other personal expenditures	1,731		10		461		443		48		2,693
Other commercial loans	1,928						72				2,000
Total	$	330,918	$	99,166	$	99,541	$	393,014	$	38,743	$	961,382
Carrying Amount	$	319,664	$	96,829	$	93,355	$	373,649	$	34,092	$	917,589
Allowance					4		149				153
Carrying Amount Net of Allowance	$	319,664	$	96,829	$	93,351	$	373,500	$	34,092	$	917,436

The outstanding balance and related carrying amount of loans acquired and accounted for under ASC 310-30 as of December 31, 2016 were $60.5 million and $43.2 million, respectively; with no required allowance for loan losses. Comparatively, the outstanding balance and related carrying amount as of December 31, 2015 of $95.8 million and $69.6 million, respectively, required an allowance for loan losses and corresponding provision expense of $153,000.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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 tables below. The tables reflect only purchased loans accounted for under ASC 310-30 and not the entire portfolio of purchased loans.

	Twelve Months Ended December 31, 2016
	Ameriana			C Financial			Community			CFS			SCB			Total
Beginning balance	$	2,160		$	114		$	1,508		$	1,188		$	642		$	5,612
Additions
Accretion	(311		)	(123		)	(1,119		)	(4,268		)	(756		)	(6,577		)
Reclassification from nonaccretable	12			82			858			3,827			393			5,172
Disposals	(232		)				(14		)	(11		)				(257		)
Ending balance	$	1,629		$	73		$	1,233		$	736		$	279		$	3,950

	Twelve Months Ended December 31, 2015
	Ameriana		C Financial			Community			CFS			SCB			Total
Beginning balance						$	2,122		$	2,400		$	868		$	5,390
Additions	$	2,160	$	145											2,305
Accretion			(31		)	(723		)	(4,050		)	(1,046		)	(5,850		)
Reclassification from nonaccretable						249			2,854			822			3,925
Disposals						(140		)	(16		)	(2		)	(158		)
Ending balance	$	2,160	$	114		$	1,508		$	1,188		$	642		$	5,612

	Twelve Months Ended December 31, 2014
	Community			CFS			SCB			Total
Beginning balance				$	4,164		$	1,388		$	5,552
Additions	$	2,234								2,234
Accretion	(231		)	(4,146		)	(1,062		)	(5,439		)
Reclassification from nonaccretable	119			2,553			577			3,249
Disposals				(171		)	(35		)	(206		)
Ending balance	$	2,122		$	2,400		$	868		$	5,390

The following table presents loans acquired during the period ending December 31, 2015, for which it was probable at acquisition that all contractually required payments would not be collected. There were no loans acquired during the period ending December 31, 2016.

	2015
	Ameriana		C Financial		Total
Contractually required payments receivable at acquisition date	$	23,172	$	2,632	$	25,804
Nonaccretable difference	11,592		637		12,229
Expected cash flows at acquisition date	11,580		1,995		13,575
Accretable difference	2,160		145		2,305
Basis in loans at acquisition date	$	9,420	$	1,850	$	11,270

76

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 7

PREMISES AND EQUIPMENT

The following table summarizes the Corporation's premises and equipment as of December 31, 2016 and 2015:

	2016			2015
Cost at December 31:
Land	$	25,035		$	26,510
Buildings and Leasehold Improvements	114,444			115,461
Equipment	65,547			64,892
Total Cost	205,026			206,863
Accumulated Depreciation and Amortization	(110,594		)	(109,215		)
Net	$	94,432		$	97,648

The Ameriana acquisition on December 31, 2015 and the C Financial acquisition on April 17, 2015 resulted in additions to premises and equipment of $13,946,000 and $7,290,000, respectively. 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 2016, 2015 and 2014 was $4,586,000, $3,456,000 and $3,258,000, respectively. The future minimum rental commitments required under the operating leases in effect at December 31, 2016, expiring at various dates through the year 2035 are as follows for the years ending December 31:

	Future Minimum Rental Commitments
2017	$	3,298
2018	1,998
2019	1,624
2020	1,388
2021	1,056
After 2021	6,487
Total Future Minimum Obligations	$	15,851

NOTE 8

GOODWILL

The Ameriana acquisition on December 31, 2015 resulted in $38,624,000 of goodwill, of which, $871,000 was recorded during the first quarter of 2016 as a measurement period adjustment. The C Financial acquisition on April 17, 2015 resulted in goodwill of $11,126,000. On June 12, 2015, the sale of FMIG resulted in a goodwill reduction of $8,474,000. 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 2016 or 2015. The Corporation tested goodwill for impairment during 2016 and 2015. 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.

	2016		2015
Balance, January 1	$	243,129	$	202,724
Goodwill acquired			48,879
Goodwill reduction			(8,474		)
Measurement period adjustment	871
Balance, December 31	$	244,000	$	243,129

77

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 9

CORE DEPOSIT AND OTHER INTANGIBLES

Core deposit and other intangibles are recorded on the acquisition date of an entity. During the measurement period, the Corporation may record subsequent adjustments to core deposit and other intangibles for provisional amounts recorded at the acquisition date. The Ameriana acquisition on December 31, 2015 resulted in a core deposit intangible of $5,342,000, of which, $2,142,000 was recorded as a measurement period adjustment in the first quarter of 2016. The C Financial acquisition on April 17, 2015 resulted in a core deposit intangible of $981,000. On June 12, 2015, the sale of FMIG resulted in an other intangible reduction of $742,000. 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.

	2016			2015
Gross carrying amount	$	61,798		$	58,360
Core deposit intangible and other intangibles acquired				4,181
Measurement period adjustment	2,142
Accumulated amortization	(49,074		)	(45,164		)
Core deposit intangible and other intangibles reduction				(742		)
Core Deposit and Other Intangibles	$	14,866		$	16,635

Amortization expense for the years ended December 31, 2016, 2015 and 2014, was $3,910,000, $2,835,000 and $2,445,000, respectively.

Estimated future amortization expense is summarized as follows:

	Amortization Expense
2017	$	3,614
2018	2,299
2019	1,914
2020	1,733
2021	1,611
After 2021	3,695
	$	14,866

NOTE 10

DEPOSITS

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

	December 31, 2016		December 31, 2015
Demand deposits	$	2,866,853	$	2,576,283
Savings deposits	1,560,752		1,518,722
Certificates and other time deposits of $100,000 or more	276,274		323,698
Other certificates and time deposits	471,247		556,476
Brokered deposits	381,372		314,468
Total deposits	$	5,556,498	$	5,289,647

At December 31, 2016 and 2015, deposits exceeding the FDIC's Standard Maximum Deposit Insurance Amount of $250,000 were $2.2 billion and $2.1 billion, respectively.

78

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

At December 31, 2016, the contractual maturities of time deposits are summarized as follows:

	Certificates and Other Time Deposits
2017	$	621,205
2018	230,560
2019	137,090
2020	65,396
2021	43,010
After 2021	31,632
	$	1,128,893

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, 2016 and 2015 were:

	December 31, 2016
	Remaining Contractual Maturity of the Agreements
	Overnight and Continuous		Up to 30 Days	30-90 Days	Greater Than 90 Days		Total
U.S. Government-sponsored mortgage-backed securities	$	129,617	1,337	10,253	$	5,273	$	146,480

	December 31, 2015
	Remaining Contractual Maturity of the Agreements
	Overnight and Continuous		Up to 30 Days	30-90 Days	Greater Than 90 Days		Total
U.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, 2016 and 2015:

	December 31, 2016		December 31, 2015
Federal funds purchased	$	120,349	$	49,721
Securities sold under repurchase agreements	146,480		155,325
Federal Home Loan Bank advances	298,923		235,652
Subordinated debentures and term loans	128,445		127,846
Total Borrowings	$	694,197	$	568,544

Securities sold under repurchase agreements consist of obligations of the Bank to other parties and are secured by U.S. Government-Sponsored Enterprise obligations. The maximum amount of outstanding agreements at any month-end during 2016 and 2015 totaled $158,185,000 and $163,128,000, respectively, and the average of such agreements totaled $145,379,000 and $143,491,000 during 2016 and 2015, respectively.

Contractual maturities of borrowings as of December 31, 2016, are as follows:

Maturities in Years Ending December 31:	Federal Funds Purchased		Securities Sold Under Repurchase Agreements		Federal Home Loan Bank Advances		Subordinated Debentures and Term Loans
2017	$	120,349	$	146,480	$	167,068	$	1,018
2018					26,717
2019					13,828
2020					31,310
2021					25,000
After 2021					35,000		132,012
ASC 805 fair value adjustments at acquisition							(4,585		)
	$	120,349	$	146,480	$	298,923	$	128,445

79

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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 142 percent of these advances depending on the type of collateral pledged. Advances, with interest rates from 0.60 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, 2016, was $291,445,000. As of December 31, 2016, the Corporation had $25,000,000 of putable advances with the FHLB.

Subordinated Debentures and Term Loans. As of December 31, 2016 and 2015, subordinated debentures and term loans totaled $128,445,000 and 127,846,000, respectively.

• 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 million of subordinated debentures at a gain of $1,250,000. As of December 31, 2016, $51,702,000 of 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 at 6.495 percent for the period from the date of issuance through September 15, 2012; interest is now an annual floating rate equal to the three-month LIBOR plus 1.56 percent, reset quarterly. Interest is payable in March, June, September and December of each year. The interest rate at December 31, 2016 and 2015 was 2.52 percent and 2.07 percent, respectively. 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 $10,310,000 and have a maturity of March 2036. Ameriana could not redeem the debenture prior to March 2011, and redemption is subject to the prior approval of the Board of Governors of the Federal Reserve System, as required by law or regulation. 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, 2016 and 2015 was 2.46 percent and 2.01 percent, respectively. 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 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 interest rate on the Senior Debt and Subordinated Debt remains fixed for the first ten (10) years and will become floating thereafter. Once the rates convert to floating on October 30, 2023, the Senior Debt will have an annual floating rate equal to the three-month LIBOR plus 2.345 percent and the Subordinated Debt will have an annual floating rate equal to the three-month LIBOR plus 4.095 percent. The Corporation has an option to redeem the Subordinated Debt in whole or in part at a redemption price equal to 100 percent of the principal amount of the redeemed Subordinated Notes, plus accrued and unpaid interest to the date of the redemption. The option of redemption is subject to the approval of the Federal Reserve Board. The Corporation has an option to redeem the Senior Debt in whole or in part at a redemption price equal to 100 percent of the principal amount of the redeemed Senior Notes, plus accrued and unpaid interest to the date of the redemption; provided, however, that no Subordinated Notes (as defined in the Issuing and Paying Agency Agreement) may remain outstanding subsequent to any early redemption of Senior Notes. The Subordinated Debt and the Senior Debt options to redeem begin with the interest payment date on October 30, 2023, or on any scheduled interest payment date thereafter. The Senior Debt agreement contains certain customary representations and warranties and financial and negative covenants. As of December 31, 2016 and 2015 the Corporation was in compliance with these covenants.

Line of Credit. As of December 31, 2016, the line of credit was no longer in place. As of December 31, 2015, there was no outstanding balance on the line of credit.

• 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. The line of credit matured on April 8, 2016 and the agreement was not renewed. Interest was payable quarterly based on one-month LIBOR plus 2.00 percent. The line of credit had a quarterly facility fee of 0.25 percent on the unused balance. The line of credit agreement contained certain customary representations and warranties and financial and negative covenants.

80

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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.

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, 2016 and 2015, 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 2016, $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, 2016 and 2015, 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 $1,001,133 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, 2016, the notional amount of customer-facing swaps was approximately $292,558,991.  This amount is offset with third party counterparties, as described above. 

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, 2016 and December 31, 2015.

Asset Derivatives

Liability Derivatives

December 31, 2016

December 31, 2015

December 31, 2016

December 31, 2015

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

Balance Sheet Location

Fair Value

Derivatives designated as hedging instruments:

Interest rate contracts

Other Assets

$

15

Other Assets

$

36

Other Liabilities

$

2,182

Other Liabilities

$

2,921

Derivatives not designated as hedging instruments:

Interest rate contracts

Other Assets

$

6,295

Other Assets

$

4,938

Other Liabilities

$

6,295

Other Liabilities

$

5,149

81

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

The amount of gain (loss) recognized in other comprehensive income is included in the table below for the periods indicated.

Derivatives in Cash Flow Hedging Relationships	Amount of Gain (Loss) Recognized in Other Comprehensive Income on Derivative (Effective Portion) For the Year Ended
	2016			2015
Interest rate products	$	(368	)	$	(1,681	)

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, 2016, 2015 and 2014.

Derivatives Not Designated as Hedging Instruments under FASB ASC 815-10	Location of Gain (Loss) Recognized in Income on Derivative	Amount of Gain (Loss) Recognized in Income on Derivative
		2016		2015			2014
Interest rate contracts	Other income	$	211	$	(53	)	$	(73	)

Derivatives Designated as Hedging Instruments under FASB ASC 815-10	Location of Loss Reclassified from Accumulated Other Comprehensive Income (Effective Portion)	Amount of Loss Reclassified from Other Comprehensive Income into Income (Effective Portion)
		2016			2015			2014
Interest rate contracts	Interest expense	$	(1,250	)	$	(1,427	)	$	(1,411	)

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, 2016, the termination value of derivatives in a net liability position related to these agreements was $3,821,000. As of December 31, 2016, the Corporation has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of $7,516,000. If the Corporation had breached any of these provisions at December 31, 2016, 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).

82

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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. Level 1 securities include equity securities. 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. 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 for 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, 2016 and 2015.

			Fair Value Measurements Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
December 31, 2016	Fair Value		(Level 1)		(Level 2)		(Level 3)
Available for sale securities:
U.S. Government-sponsored agency securities	$	100			$	100
State and municipal	363,658				358,524		$	5,134
U.S. Government-sponsored mortgage-backed securities	312,292				312,292
Corporate obligations	31						31
Equity securities	20,781		$	18,765	2,012		4
Interest rate swap asset	6,295				6,295
Interest rate cap	15				15
Interest rate swap liability	8,477				8,477

83

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

			Fair Value Measurements Using:
			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs		Significant Unobservable Inputs
December 31, 2015	Fair Value		(Level 1)	(Level 2)		(Level 3)
Available for sale securities:
U.S. Government-sponsored agency securities	$	104		$	104
State and municipal	305,911			300,014		$	5,897
U.S. Government-sponsored mortgage-backed securities	346,266			346,266
Certificates of deposit	2,176			2,176
Corporate obligations	31					31
Equity securities	3,912			3,908		4
Interest rate swap asset	4,938			4,938
Interest rate cap	36			36
Interest rate swap liability	8,070			8,070

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, 2016 and 2015.

	Available for Sale Securities
	For The Year Ended
	December 31, 2016			December 31, 2015
Beginning Balance	$	5,932		$	6,646
Included in other comprehensive income	(223		)	199
Principal payments	(540		)	(913		)
Ending balance	$	5,169		$	5,932

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, 2016 or 2015.

TRANSFERS BETWEEN LEVELS

There were no transfers in or out of Level 3 during 2016 or 2015.

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, 2016 and 2015.

			Fair Value Measurements Using
			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs
December 31, 2016	Fair Value		(Level 1)	(Level 2)	(Level 3)
Impaired Loans (collateral dependent)	$	15,318			$	15,318
Other real estate owned	$	1,612			$	1,612

			Fair Value Measurements Using
			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs	Significant Unobservable Inputs
December 31, 2015	Fair Value		(Level 1)	(Level 2)	(Level 3)
Impaired Loans (collateral dependent)	$	7,066			$	7,066
Other real estate owned	$	5,529			$	5,529

84

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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 2016, 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 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 andor 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, 2016 and 2015.

December 31, 2016	Fair Value		Valuation Technique	Unobservable Inputs	Range (Weighted-Average)
State and municipal securities	$	5,134	Discounted cash flow	Maturity Call Date US Muni BQ curve Discount rate	1 month to 20 years A- to BBB- .69% - 5%
Corporate obligations and Equity securities	$	35	Discounted cash flow	Risk free rate plus Premium for illiquidity	3 month LIBOR plus 200 bps
Impaired loans (collateral dependent)	$	15,318	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	0% - 10% (1%)
Other real estate owned	$	1,612	Appraisals	Discount to reflect current market conditions	0% - 10% (9%)

December 31, 2015	Fair Value		Valuation Technique	Unobservable Inputs	Range (Weighted-Average)
State and municipal securities	$	5,897	Discounted cash flow	Maturity Call Date US Muni BQ curve Discount rate	1 month to 15 years A- to BBB- .80% - 5%
Corporate obligations and Equity securities	$	35	Discounted cash flow	Risk free rate plus Premium for illiquidity	3 month LIBOR plus 200 bps
Impaired loans (collateral dependent)	$	7,066	Collateral based measurements	Discount to reflect current market conditions and ultimate collectability	0% - 50% (2%)
Other real estate owned	$	5,529	Appraisals	Discount to reflect current market conditions	0% - 20% (2%)

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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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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, 2016 and 2015.

	2016
	Carrying Amount		Quoted 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	$	127,927	$	127,927
Interest-bearing time deposits	24,459		24,459
Investment securities available for sale	696,862		18,765		$	672,928	$	5,169
Investment securities held to maturity	607,643				597,246		14,687
Loans held for sale	2,929				2,929
Loans	5,073,608						4,933,552
Federal Home Loan Bank stock	17,964				17,964
Interest rate swap asset	6,310				6,310
Interest receivable	26,194				26,194
Liabilities at December 31:
Deposits	$	5,556,498	$	4,427,605	$	1,111,491
Borrowings:
Federal funds purchased	120,349				120,349
Securities sold under repurchase agreements	146,480				146,449
Federal Home Loan Bank advances	298,923				297,465
Subordinated debentures and term loans	128,445				105,930
Interest rate swap liability	8,477				8,477
Interest payable	3,110				3,110

	2015
	Carrying Amount		Quoted 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	$	102,170
Interest-bearing time deposits	32,315		32,315
Investment securities available for sale	658,400				$	652,468	$	5,932
Investment securities held to maturity	618,599				598,082		34,298
Loans held for sale	9,894				9,894
Loans	4,631,369						4,539,940
Federal Reserve and Federal Home Loan Bank stock	37,633				37,633
Interest rate swap asset	4,974				4,974
Interest receivable	24,415				24,415
Liabilities at December 31:
Deposits	$	5,289,647	$	4,095,004	$	1,177,142
Borrowings:
Federal funds purchased	49,721				49,721
Securities sold under repurchase agreements	155,325				155,325
Federal Home Loan Bank advances	235,652				236,375
Subordinated debentures and term loans	127,846				103,643
Interest rate swap liability	8,070				8,070
Interest payable	3,092				3,092

86

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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:

	2016		2015
Amounts of commitments:
Loan commitments to extend credit	$	2,057,878	$	1,547,048
Standby letters of credit	$	46,010	$	46,734

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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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 16

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, 2016 and 2015:

	Accumulated Other Comprehensive Income (Loss)
	Unrealized Gains (Losses) on Securities Available for Sale			Unrealized Gains (Losses) on Cash Flow Hedges			Unrealized Gains (Losses) on Defined Benefit Plans			Total
Balance at December 31, 2015	$	12,325		$	(2,347	)	$	(11,340	)	$	(1,362	)
Other comprehensive income before reclassifications	(9,087		)	(240		)	(470		)	(9,797		)
Amounts reclassified from accumulated other comprehensive income	(2,203		)	813			(1,032		)	(2,422		)
Period change	(11,290		)	573			(1,502		)	(12,219		)
Balance at December 31, 2016	$	1,035		$	(1,774	)	$	(12,842	)	$	(13,581	)
Balance at December 31, 2014	$	14,098		$	(2,182	)	$	(13,546	)	$	(1,630	)
Other comprehensive income before reclassifications	(37		)	(1,093		)	2,404			1,274
Amounts reclassified from accumulated other comprehensive income	(1,736		)	928			(198		)	(1,006		)
Period change	(1,773		)	(165		)	2,206			268
Balance at December 31, 2015	$	12,325		$	(2,347	)	$	(11,340	)	$	(1,362	)

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 years ended December 31, 2016, 2015 and 2014:

	Amount Reclassified from Accumulated Other Comprehensive Income (Loss) For the Year Ended December 31,
Details about Accumulated Other Comprehensive Income (Loss) Components	2016			2015			2014			Affected Line Item in the Statements of Income
Unrealized gains (losses) on available for sale securities (1)
Realized securities gains reclassified into income	$	3,389		$	2,670		$	3,581		Other income - net realized gains on sales of available for sale securities
Related income tax expense	(1,186		)	(934		)	(1,253		)	Income tax expense
	$	2,203		$	1,736		$	2,328
Unrealized gains (losses) on cash flow hedges (2)
Interest rate contracts	$	(1,250	)	$	(1,427	)	$	(1,411	)	Interest expense - subordinated debentures and term loans
Related income tax benefit	437			499			493			Income tax expense
	$	(813	)	$	(928	)	$	(918	)
Unrealized gains (losses) on defined benefit plans
Amortization of net loss and prior service costs	$	1,588		$	305		$	520		Other expenses - salaries and employee benefits
Related income tax benefit (expense)	(556		)	(107		)	(182		)	Income tax expense
	$	1,032		$	198		$	338
Total reclassifications for the period, net of tax	$	2,422		$	1,006		1,748

⁽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.

88

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 17

REGULATORY CAPITAL AND DIVIDENDS

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 CET1 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 CET1 capital to risk-weighted assets ratio. The capital conservation buffer is being phased in from zero percent to 2.50 percent by 2019. As of January 1, 2016, the Corporation is required to hold a capital conservation buffer of 0.625 percent, increasing by that amount each successive year until 2019. Under Basel III, the Corporation and Bank elected to opt-out of including AOCI in regulatory capital.

As of December 31, 2016, 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, 2016 and December 31, 2015 were as follows:

					Prompt Corrective Action Thresholds
	Actual				Adequately Capitalized				Well Capitalized
December 31, 2016	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total risk-based capital to risk-weighted assets
First Merchants Corporation	$	851,521	14.21	%	$	479,470	8.00	%	N/A		N/A
First Merchants Bank	800,598		13.30		481,490		8.00		$	601,862	10.00	%
Tier 1 capital to risk-weighted assets
First Merchants Corporation	$	720,484	12.02	%	$	359,603	6.00	%	N/A		N/A
First Merchants Bank	734,561		12.20		361,117		6.00		$	481,490	8.00	%
Common equity tier 1 capital to risk-weighted assets
First Merchants Corporation	$	665,445	11.10	%	$	269,702	4.50	%	N/A		N/A
First Merchants Bank	734,561		12.20		270,838		4.50		$	391,210	6.50	%
Tier 1 capital to average assets
First Merchants Corporation	$	720,484	10.54	%	$	273,456	4.00	%	N/A		N/A
First Merchants Bank	734,561		10.78		272,461		4.00		$	340,576	5.00	%
					Prompt Corrective Action Thresholds
	Actual				Adequately Capitalized				Well Capitalized
December 31, 2015	Amount		Ratio		Amount		Ratio		Amount		Ratio
Total risk-based capital to risk-weighted assets
First Merchants Corporation	$	783,776	14.94	%	$	419,809	8.00	%	N/A		N/A
First Merchants Bank	739,793		13.98		423,242		8.00		$	529,052	10.00	%
Tier 1 capital to risk-weighted assets
First Merchants Corporation	$	656,323	12.51	%	$	314,857	6.00	%	N/A		N/A
First Merchants Bank	677,340		12.80		317,431		6.00		$	423,242	8.00	%
Common equity tier 1 capital to risk-weighted assets
First Merchants Corporation	$	603,063	11.49	%	$	236,143	4.50	%	N/A		N/A
First Merchants Bank	677,340		12.80		238,074		4.50		$	343,884	6.50	%
Tier 1 capital to average assets
First Merchants Corporation	$	656,323	10.85	%	$	242,001	4.00	%	N/A		N/A
First Merchants Bank	677,340		11.22		241,423		4.00		$	301,779	5.00	%

89

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

Management believes that all of the above capital ratios are meaningful measurements for evaluating the safety and soundness of the Corporation. Traditionally, the banking regulators have assessed bank and bank holding company capital adequacy based on both the amount and the composition of capital, the calculation of which is prescribed in federal banking regulations. The Federal Reserve focuses its assessment of capital adequacy on a component of Tier 1 capital known as CET1. Because the Federal Reserve has long indicated that voting common shareholders' equity (essentially Tier 1 risk-based capital less preferred stock and non-controlling interest in subsidiaries) generally should be the dominant element in Tier 1 risk-based capital, this focus on CET1 is consistent with existing capital adequacy categories. 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.

Because these measures are not defined in GAAP, they are considered non-GAAP financial measures. Non-GAAP financial measures have inherent limitations, are not required to be uniformly applied, and are not audited. Although these non-GAAP financial measures are frequently used by investors to evaluate a company, they have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analyses of results as reported under GAAP. For a reconciliation of GAAP measures to regulatory measures (non-GAAP), see additional details within 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.

Dividends

The Corporation's principal source of funds for dividend payments to shareholders is dividends received from the Bank. Banking regulations limit the maximum amount of dividends that a bank may pay without requesting prior approval of regulatory agencies. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the bank’s retained net income (as defined) for the current year plus those for the previous two years, subject to the capital requirements described above.  As of December 31, 2016, the amount available without prior regulatory approval for 2017 dividends from the Corporation’s subsidiaries (both banking and non-banking) was $97,225,000.

Additionally, 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.

Stock Repurchase Program

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. 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.

NOTE 18

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 $369,592,000, $312,204,000 and $254,223,000 at December 31, 2016, 2015 and 2014, respectively.  The amount of capitalized servicing assets is considered immaterial.

NOTE 19

SHARE-BASED COMPENSATION

Stock options and 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, 2016, the Corporation did not have any outstanding DSUs.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

The Corporation’s 2009 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, 2016, 2015, and 2014 was $2,600,000, $2,270,000, and $2,177,000, 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 2016 or 2015. The estimated fair value of the stock options granted in prior years was calculated using a Black-Scholes option pricing model.  The weighted-average grant date fair value was $8.13 for stock options granted during the year ended December 31, 2014.

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.

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 3.8 percent for the year ended December 31, 2016, based on historical experience.

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

	Years Ended December 31,
	2016			2015			2014
Stock and ESPP Options
Pre-tax compensation expense	$	76		$	101		$	237
Income tax expense (benefit)	18			4			(47		)
Stock and ESPP option expense, net of income taxes	$	94		$	105		$	190
Restricted Stock Awards
Pre-tax compensation expense	$	2,524		$	2,169		$	1,940
Income tax benefit	(883		)	(749		)	(679		)
Restricted stock awards expense, net of income taxes	$	1,641		$	1,420		$	1,261
Total Share-Based Compensation:
Pre-tax compensation expense	$	2,600		$	2,270		$	2,177
Income tax benefit	(865		)	(745		)	(726		)
Total share-based compensation expense, net of income taxes	$	1,735		$	1,525		$	1,451

As of December 31, 2016, unrecognized compensation expense related to RSAs was $3,527,000 and is expected to be recognized over weighted-average period of 1.39 years. The Corporation did not have any unrecognized compensation expense related to stock options as of December 31, 2016.

Stock option activity under the Corporation's stock option plans, as of December 31, 2016, and changes during the year ended December 31, 2016, were as follows:

	Number of Shares		Weighted-Average Exercise Price		Weighted Average Remaining Contractual Term (in Years)	Aggregate Intrinsic Value
Outstanding at January 1, 2016	442,012		$	19.99
Exercised	(128,848	)	$	19.37
Canceled	(52,953	)	$	25.09
Outstanding December 31, 2016	260,211		$	19.26	2.71	$	4,785,982
Vested and Expected to Vest at December 31, 2016	260,211		$	19.26	2.71	$	4,785,982
Exercisable at December 31, 2016	260,211		$	19.26	2.71	$	4,785,982

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

 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 2016 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, 2016.  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, 2016 and 2015 was $1,641,000 and $921,000, respectively. Cash receipts of stock options exercised during 2016 and 2015 were $2,495,000 and $1,461,000, respectively.

The following table summarizes information on unvested RSAs outstanding as of December 31, 2016:

	Number of Shares		Weighted-Average Grant Date Fair Value
Unvested RSAs at January 1, 2016	354,504		$	19.65
Granted	124,563		$	24.01
Forfeited	(9,594	)	$	21.99
Vested	(141,126	)	$	16.62
Unvested RSAs at December 31, 2016	328,347		$	22.87

The grant date fair value of ESPP options was estimated at the beginning of the October 1, 2016, quarterly offering period of approximately $23,000. The ESPP options vested during the three months ending December 31, 2016, leaving no unrecognized compensation expense related to unvested ESPP options at December 31, 2016.

NOTE 20

PENSION AND OTHER POST RETIREMENT BENEFIT PLANS

The Corporation’s defined-benefit pension plans cover approximately 19 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, 2016 and 2015.

	2016			2015
Change in Benefit Obligation:
Benefit obligation at beginning of year	$	71,747		$	80,650
Service cost	9			55
Interest cost	3,273			3,087
Actuarial loss (gain)	2,679			(5,617		)
Benefits paid	(5,263		)	(6,428		)
Net transfers in from Ameriana acquisition	11,645
Benefit obligation at end of year	$	84,090		$	71,747
Change in Plan Assets:
Fair value of plan assets at beginning of year	$	71,396		$	77,139
Actual return on plan assets	6,959			153
Employer contributions	739			532
Benefits paid	(5,263		)	(6,428		)
Ameriana acquisition	9,726
End of year	83,557			71,396
Funded status at end of year	$	(533	)	$	(351	)
Assets and Liabilities Recognized in the Balance Sheets:
Deferred tax asset	$	7,041		$	7,461
Assets	$	5,028		$	4,006
Liabilities	$	5,561		$	4,357
Amounts Recognized in Accumulated Other Comprehensive Income Not Yet Recognized as Components of Net Periodic (Benefit) Cost, net of tax, consist of:
Accumulated loss	$	(12,624	)	$	(13,857	)
Prior service credit	(451		)	(305		)
	$	(13,075	)	$	(14,162	)

92

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

The actuarial (gain) loss recognized in 2016 and 2015 was primarily a result of discount rate assumption fluctuations.

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 were merged into the First Merchants Corporation Retirement Plan in 2016.

The accumulated benefit obligation for all defined benefit plans was $84,090,000 and $71,747,000 at December 31, 2016 and 2015, respectively.

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

	December 31, 2016		December 31, 2015
Projected benefit obligation	$	5,561	$	4,357
Accumulated benefit obligation	$	5,561	$	4,357
Fair value of plan assets

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

	December 31, 2016			December 31, 2015			December 31, 2014
Service cost	$	9		$	55		$	73
Interest cost	3,273			3,087			3,235
Expected return on plan assets	(4,508		)	(4,471		)	(4,467		)
Amortization of prior service costs	79			64			81
Amortization of net loss	1,656			1,722			478
Net periodic pension (benefit) cost	$	509		$	457		$	(600	)

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

	December 31, 2016			December 31, 2015		December 31, 2014
Net periodic pension (benefit) cost	$	509		$	457	$	(600	)
Net gain (loss)	(228		)	1,299		(12,203		)
Amortization of loss	1,656			1,722		478
Amortization of prior service cost	79			64		81
Total recognized in other comprehensive income (loss)	1,507			3,085		(11,644		)
Total recognized in net periodic pension cost and other comprehensive income (loss)	$	998		$	2,628	$	(11,044	)

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, 2016			December 31, 2015			December 31, 2014
Amortization of net loss	$	(1,208	)	$	(1,505	)	$	(1,770	)
Amortization of prior service cost	(90		)	(61		)	(64		)
Total	$	(1,298	)	$	(1,566	)	$	(1,834	)

93

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

Significant assumptions include:

	December 31, 2016		December 31, 2015		December 31, 2014
Weighted-average Assumptions Used to Determine Benefit Obligation:
Discount rate	4.20	%	4.50	%	4.00	%
Rate of compensation increase for accruing active participants	3.00	%	3.00	%	3.00	%
Weighted-average Assumptions Used to Determine Cost:
Discount rate	4.50	%	4.00	%	4.80	%
Expected return on plan assets	6.00	%	6.00	%	6.00	%
Rate of compensation increase for accruing active participants	3.00	%	3.00	%	3.00	%

At December 31, 2016 and 2015, 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 ERISA and any other applicable statutes.

The plans’ risk management practices include semi-annual 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 individual non-investment grade bonds.

At December 31, 2016, the maturities of the plans’ debt securities ranged from 15 days to 8.03 years, with a weighted average maturity of 3.97 years. 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.

The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid as of December 31, 2016. The minimum contribution required in 2017 will likely be zero but the Corporation may decide to make a discretionary contribution during the year.

2017	$	5,756
2018	5,644
2019	5,802
2020	5,688
2021	5,557
After 2021	27,118
	$	55,565

Plan assets are re-balanced quarterly. At December 31, 2016 and 2015, plan assets by category are as follows:

	December 31, 2016				December 31, 2015
	Actual		Target		Actual		Target
Cash and cash equivalents	4.5	%	3.0	%	2.2	%	2.0	%
Equity securities	55.8		55.0		58.1		60.0
Debt securities	37.7		40.0		37.4		36.0
Alternative investments	2.0		2.0		2.3		2.0
	100.0	%	100.0	%	100.0	%	100.0	%

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 $3,441,000, $3,526,000 and $3,396,000 for 2016, 2015 and 2014, respectively.

94

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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 Corporation elected to terminate this plan effective December 31, 2017. As a result of the termination, the Corporation recognized a curtailment gain of $2,157,000 as a component of salaries and benefits expense in the accompanying CONSOLIDATED STATEMENTS OF INCOME. The obligations payable under the plans totaled $54,000 and $1,403,000 at December 31, 2016 and 2015, respectively. Post retirement plan expense totaled $(2,437,000), $(127,000) and $97,000 for the years ending December 31, 2016, 2015 and 2014, 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 $64,064,000 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 $19,493,000 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, 2016 and 2015.

			Fair Value Measurements Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
December 31, 2016	Fair Value		(Level 1)		(Level 2)		(Level 3)
Cash & Cash Equivalents	$	3,778	$	3,778
Corporate Bonds and Notes	10,646		10,646
Government Agency and Municipal Bonds and Notes	6,855				$	6,855
Certificates of Deposit	1,268				1,268
Party-in-Interest Investments
Common Stock	2,278		2,278
Common Bond Fund	4,744				4,744
Common Equity Fund	6,626				6,626
Mutual Funds
Taxable Bond	7,974		7,974
Large Cap Equity	19,611		19,611
Mid Cap Equity	10,304		10,304
Small Cap Equity	4,680		4,680
International Equity	3,093		3,093
Specialty Alternative Equity	1,700		1,700
	$	83,557	$	64,064	$	19,493

			Fair Value Measurements Using
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
December 31, 2015	Fair Value		(Level 1)		(Level 2)		(Level 3)
Cash & Cash Equivalents	$	1,608	$	1,608
Corporate Bonds and Notes	9,113		9,113
Government Agency and Municipal Bonds and Notes	6,993				$	6,993
Certificates of Deposit	1,511				1,511
Party-in-Interest Investments
Common Stock	1,538		1,538
Common Bond Fund	4,647				4,647
Common Equity Fund	5,812				5,812
Mutual Funds
Taxable Bond	4,536		4,536
Large Cap Equity	18,528		18,528
Mid Cap Equity	8,537		8,537
Small Cap Equity	3,578		3,578
International Equity	3,353		3,353
Specialty Alternative Equity	1,642		1,642
	$	71,396	$	52,433	$	18,963

95

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 21

INCOME TAX

The reconciliation between income tax expense expected at the U.S. federal statutory tax rate and the reported income tax expense is summarized in the following table for years ended December 31, 2016, 2015, 2014:

	2016			2015			2014
Reconciliation of Federal Statutory to Actual Tax Expense:
Federal Statutory Income Tax at 35%	$	38,031		$	31,867		$	28,800
Tax-exempt Interest Income	(8,749		)	(7,083		)	(5,148		)
Basis Difference on Sale of Insurance Subsidiary				2,252
Stock Compensation	27			34			36
Earnings on Life Insurance	(1,486		)	(1,012		)	(1,271		)
Tax Credits	(564		)	(583		)	(911		)
Other	350			190			617
Income Tax Expense	$	27,609		$	25,665		$	22,123

Income tax expense consists of the following components for the years ended December 31, 2016, 2015, 2014:

	2016		2015		2014
Income Tax Expense for the Year Ended December 31:
Currently Payable:
Federal	$	18,998	$	21,221	$	7,075
State
Deferred:
Federal	8,233		3,952		14,538
State	378		492		510
Income Tax Expense	$	27,609	$	25,665	$	22,123

Significant components of the net deferred tax assets (liabilities) resulting from temporary differences were as follows at December 31, 2016 and 2015:

	2016			2015
Deferred Tax Asset at December 31:
Assets:
Differences in Accounting for Loan Losses	$	26,315		$	25,867
Differences in Accounting for Loan Fees	1,918			762
Differences in Accounting for Loans and Securities	5,689			9,359
Deferred Compensation	3,471			5,100
Difference in Accounting for Pensions and Other Employee Benefits	83			2,247
Federal & State Income Tax Loss Carryforward and Credits	16,643			23,737
Other	4,210			9,310
Total Assets	58,329			76,382
Liabilities:
Differences in Depreciation Methods	8,216			7,742
State Income Tax	237			591
Net Unrealized Gain on Securities Available for Sale	557			6,636
Gain on FDIC Modified Whole Bank Transaction	1,126			1,405
Other	623			717
Total Liabilities	10,759			17,091
Net Deferred Tax Asset Before Valuation Allowance	47,570			59,291
Valuation allowance:
Beginning Balance	(15,736		)	(17,568		)
Decrease/(Increase) During the Year	5,921			1,832
Ending Balance	(9,815		)	(15,736		)
Net Deferred Tax Asset	$	37,755		$	43,555

96

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

The $5,800,000 decrease in the Corporation’s net deferred tax asset was due the combination of a decrease in deferred tax assets offset by a decrease in deferred tax liabilities. The largest deferred tax asset decreases were associated with accounting for loans, other real estate owned, federal net operating loss carryforwards, and pensions and other employee benefits of $3,670,000, $2,592,000, $2,308,000, and $2,164,000, 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 $6,079,000.

As of December 31, 2016, the Corporation has approximately $91,143,000 of state NOL carryforwards available to offset future state taxable income, which will expire beginning in 2020. These NOL carryforwards along with normal timing differences between book and tax result in total state deferred tax assets of $10,491,000. Management believes it is more likely than not that the benefit from certain of these state NOL carryforwards and certain other state deferred tax assets will not be fully realized. In recognition of this risk, the Corporation has recorded a valuation allowance of $9,815,000 against its state deferred tax assets.

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 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, 2016, would have been approximately $8,847,000.

The Corporation or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions.  The Corporation is generally no longer subject to U.S. federal, state and local income tax examinations by tax authorities for tax years before 2013.

NOTE 22

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:

	2016					2015					2014
			Weighted-Average Shares					Weighted-Average Shares					Weighted-Average Shares
Basic net income per share:
Net income available to common stockholders	$	81,051	40,767,343	$	1.99	$	65,384	37,816,399	$	1.73	$	60,162	36,266,356	$	1.66
Effect of dilutive stock options and warrants			245,790					271,834					288,253
Diluted net income per share:
Net income available to common stockholders	$	81,051	41,013,133	$	1.98	$	65,384	38,088,233	$	1.72	$	60,162	36,554,609	$	1.65

Options to purchase 51,949, 286,119, and 543,514 shares of common stock with weighted average exercise prices of $19.26, $19.99, and $20.99 at December 31, 2016, 2015 and 2014 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.

97

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 23

QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)

The following table sets forth certain quarterly results for the years ended December 31, 2016 and 2015:

	2016								2015
	First		Second		Third		Fourth		First		Second		Third		Fourth
Interest income	$	61,227	$	62,704	$	64,376	$	65,005	$	52,944	$	55,202	$	56,538	$	56,514
Interest expense	6,772		6,742		6,694		6,631		5,968		6,171		6,215		6,440
Net interest income	54,455		55,962		57,682		58,374		46,976		49,031		50,323		50,074
Provision for loan losses	550		790		1,900		2,417				417
Net interest income after provision for loan losses	53,905		55,172		55,782		55,957		46,976		48,614		50,323		50,074
Non-interest income	15,837		16,385		16,861		16,120		15,399		24,106		16,332		14,031
Non-interest expense	46,475		44,835		44,115		41,934		40,369		45,896		43,031		45,510
Income before income tax expense	23,267		26,722		28,528		30,143		22,006		26,824		23,624		18,595
Income tax expense	5,574		6,716		7,469		7,850		5,834		8,856		6,557		4,418
Net income available to common stockholders	$	17,693	$	20,006	$	21,059	$	22,293	$	16,172	$	17,968	$	17,067	$	14,177
Basic EPS	$	0.43	$	0.50	$	0.51	$	0.55	$	0.43	$	0.47	$	0.46	$	0.37
Diluted EPS	$	0.43	$	0.49	$	0.51	$	0.55	$	0.43	$	0.47	$	0.45	$	0.37
Average Shares Outstanding:
Basic	40,690,573		40,751,720		40,779,423		40,846,650		37,709,883		37,793,448		37,850,827		37,908,873
Diluted	40,916,972		40,969,111		41,025,784		41,124,179		38,000,074		38,043,359		38,118,199		38,190,694

NOTE 24

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, 2016		December 31, 2015
Assets
Cash	$	31,944	$	43,622
Investment in subsidiaries	978,291		932,372
Investment securities	18,765
Premises and equipment	1,260		1,361
Interest receivable	47		47
Goodwill	448		448
Cash surrender value of life insurance	1,082		1,041
Tax asset, deferred and receivable	521		2,024
Other assets	5,274		5,195
Total assets	$	1,037,632	$	986,110
Liabilities
Subordinated debentures and term loans	$	127,427	$	127,663
Interest payable	880		873
Other liabilities	7,668		7,065
Total liabilities	135,975		135,601
Stockholders' equity	901,657		850,509
Total liabilities and stockholders' equity	$	1,037,632	$	986,110

98

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

Condensed Statements of Income and Comprehensive Income

	December 31, 2016			December 31, 2015			December 31, 2014
Income
Dividends from subsidiaries	$	33,546		$	39,032		$	53,231
Gain on the sale of insurance subsidiary				8,265
Gain on cancellation of subordinated debentures				1,250
Other income	143			197			538
Total income	33,689			48,744			53,769
Expenses
Interest expense	7,185			6,661			6,616
Salaries and employee benefits	639			3,023			3,128
Net occupancy and equipment expenses	832			464			442
Other outside services	967			1,455			458
Professional services	279			636			409
Other expenses	(470		)	1,234			1,132
Total expenses	9,432			13,473			12,185
Income before income tax benefit (expense) and equity in undistributed income of subsidiaries	24,257			35,271			41,584
Income tax benefit (expense)	3,243			(974		)	3,999
Income before equity in undistributed income of subsidiaries	27,500			34,297			45,583
Equity in undistributed (distributions in excess of) income of subsidiaries	53,551			31,087			14,579
Net income available to common stockholders	$	81,051		$	65,384		$	60,162
Net income	$	81,051		$	65,384		$	60,162
Other comprehensive income (loss)	(12,219		)	268			4,780
Comprehensive income	$	68,832		$	65,652		$	64,942

Condensed Statement of Cash Flows

	Year Ended December 31,
	2016			2015			2014
Cash Flow From Operating Activities:
Net income	$	81,051		$	65,384		$	60,162
Adjustments to Reconcile Net Income to Net Cash:
Share-based compensation	1,166			843			887
Distributions in excess of (equity in undistributed) income of subsidiaries	(53,551		)	(31,087		)	(14,579		)
Gain on sale of insurance subsidiary				(8,265		)
Gain on cancellation of subordinated debentures				(1,250		)
Net Change in:
Other assets	833			(441		)	2,425
Other liabilities	849			(1,486		)	1,466
Investment in subsidiaries - operating activities	(1,938		)	197			(4,517		)
Net cash provided by operating activities	28,410			23,895			45,844
Cash Flow From Investing Activities:
Purchase of securities available for sale	(19,804		)
Net cash paid in acquisition				(14,500		)	(12,832		)
Proceeds from business divestitures				16,000
Other				575
Net cash provided (used) in investing activities	(19,804		)	2,075			(12,832		)
Cash Flow From Financing Activities:
Cash dividends	(22,203		)	(15,654		)	(10,694		)
Repayment of borrowings				(3,750		)
Proceeds from issuance of long-term debt
Preferred stock redemption under small business lending fund
Stock issued under employee benefit plans	462			460			478
Stock issued under dividend reinvestment and stock purchase plan	835			661			523
Stock options exercised	2,602			1,531			564
Stock redeemed	(1,980		)	(1,640		)	(1,067		)
Net cash used by financing activities	(20,284		)	(18,392		)	(10,196		)
Cash, beginning of the year	43,622			36,044			13,228
Cash, end of year	$	31,944		$	43,622		$	36,044

99

PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 25

ACCOUNTING MATTERS

FASB Accounting Standards Update No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment

Summary - The FASB has issued Accounting Standards Update (ASU) No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.

To simplify the subsequent measurement of goodwill, the amendments eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable.

The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary.

The amendments should be applied on a prospective basis. The nature of and reason for the change in accounting principle should be disclosed upon transition. A public business entity that is a U.S. Securities and Exchange Commission (SEC) filer should adopt the amendments for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. A public business entity that is not an SEC filer should adopt the amendments for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2020. All other entities, including not-for-profit entities, which adopt the amendments should do so for their annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2021. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Adoption of this ASU is not expected to have a significant effect on the Corporation’s consolidated financial statements.

FASB Accounting Standards Update No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business

Summary - The FASB has issued Accounting Standards Update (ASU) No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, clarifying the definition of a business. The amendments affect all companies and other reporting organizations that must determine whether they have acquired or sold a business.

The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill, and consolidation. The amendments are intended to help companies and other organizations evaluate whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments provide a more robust framework to use in determining when a set of assets and activities is a business. They also provide more consistency in applying the guidance, reduce the costs of application, and make the definition of a business more operable.

For public companies, the amendments are effective for annual periods beginning after December 15, 2017, including interim periods within those periods. For all other companies and organizations, the amendments are effective for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2019. Adoption of this ASU is not expected to have a significant effect on the Corporation’s consolidated financial statements.

FASB Accounting Standards Update No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments

Summary - The FASB has issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This new guidance was issued to address concerns that current generally accepted accounting principles (GAAP) restricts the ability to record credit losses that are expected, but do not yet meet the “probable” threshold by replacing the current “incurred loss” model for recognizing credit losses with an “expected life of loan loss” model referred to as the Current Expected Credit Loss (CECL) model.

Under the CECL model, certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, are required to be presented at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current GAAP, which delays recognition until it is probable a loss has been incurred. The change could materially affect how the allowance for loan losses is determined and cause a charge to earnings through the provision for loan losses. Such would adversely affect the financial condition of the Corporation.

The ASU is effective for SEC filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019 (i.e., January 1, 2020, for calendar year entities). Early application will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

The impact of CECL model implementation is being evaluated, but it’s expected a one-time cumulative-effect adjustment to the allowance for loan losses will be recognized in retained earnings on the consolidated balance sheet as of the beginning of the first reporting period in which the new standard is effective, as is consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. The magnitude of any such adjustment or the overall impact of the new standard on financial condition or results of operations cannot yet be determined.

FASB Accounting Standards Update No. 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting

Summary - The amendments in ASU 2016-09 simplify several aspects of accounting for employee share-based payments including income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some areas of the simplification apply only to nonpublic entities. The new guidance will require all income tax effects of awards to be recognized as income tax expense or benefit in the income statement when the awards vest or are settled and additional paid in capital pools will be eliminated. The guidance requires companies to present excess tax benefits as an operating activity on the statement of cash flows rather than as a financing activity. Companies will be required to account for forfeitures of share-based payments by recognizing forfeitures of awards as they occur or estimating the number of awards expected to be forfeited and adjusting the estimate when it is likely to change, as currently required, through an accounting policy election. The guidance will increase the amount an employer can withhold to cover income taxes on awards and still qualify for the exception to liability classification for shares used to satisfy the employer's income tax withholding obligation. The guidance requires an employer to classify the cash paid to a tax authority when shares are withheld to satisfy its statutory income tax withholding obligation as a financing activity on the statement of cash flows.

For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. Early adoption will be permitted in any interim or annual period for which financial statements have not yet been issued or have not been made available for issuance, however all of the guidance must be adopted in the same period. If early adoption is elected in an interim period, any adjustments should be reflected as of the beginning of the annual period that includes that interim period. Adoption of this ASU is not expected to have a significant effect on the Corporation’s consolidated financial statements.

FASB Accounting Standards Update No. 2016-02 - Leases (Topic 842)

Summary - The FASB has issued its new lease accounting guidance in Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842).

Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date:

• A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and

• A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.

Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing.

Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Nonpublic business entities should apply the amendments for fiscal years beginning after December 15, 2019 (i.e., January 1, 2020, for a calendar year entity), and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted for all public business entities and all nonpublic business entities upon issuance.

Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. The impact of this ASU is being evaluated, but it’s expected a one-time adjustment to the Corporation’s other assets and other liabilities on the consolidated balance sheet will occur as of the beginning of the first reporting period in which the new standard is effective. The magnitude of any such adjustment or the overall impact of the new standard on financial condition, results of operations and regulatory capital cannot yet be determined.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

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

Summary - 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;

• 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;

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

• 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. For private companies, not-for-profit organizations, and employee benefit plans, the new guidance becomes effective for fiscal years beginning after December 15, 2018, and for interim periods within fiscal years beginning after December 15, 2019. 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 this ASU is not expected to have a significant effect on the Corporation’s consolidated financial statements.

FASB Accounting Standards Updates No. 2014-09, Revenue from Contracts with Customers (Topic 606):

Summary - The FASB has issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). The amendments in this update supersede virtually all existing GAAP revenue recognition guidance, including most industry-specific revenue recognition guidance. ASU 2014-09 creates a single, principle-based revenue recognition framework and will require entities to apply significantly more judgment and expanded disclosures surrounding revenue recognition. The core principle requires and entity to recognize revenue in a manner that depicts the transfer of goods or services to customers at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those good or services. ASU 2014-09 applies to contracts with customers to provide goods and services, with certain exclusion such as lease contracts, financing arrangements and financial instruments. The amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2017. Early adoption is permitted for annual reporting periods beginning after December 15, 2016.

The Corporation’s revenue is comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and non-interest income. ASU 2014-09 could require the Corporation to change how certain recurring revenue streams are recognized; however, these changes are not expected to have a significant impact on the Corporation’s financial statements. The impact of ASU 2014-09 on components of non-interest income is still being evaluated. Adoption of the standard is required in the first quarter of 2018 with a cumulative effect adjustment to opening retained earnings if such adjustment is deemed to be significant.

NOTE 26

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.

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PART II: ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(table dollar amounts in thousands, except share data)

NOTE 27

SUBSEQUENT EVENTS

The Arlington Bank Merger

On January 25, 2017, the Corporation, the Bank and The Arlington Bank, an Ohio savings bank ("Arlington Bank"), entered into an Agreement and Plan of Reorganization and Merger, pursuant to which Arlington Bank will, subject to the terms and conditions of the merger agreement, merge with and into the Bank, whereupon the separate corporate existence of Arlington Bank will cease and the Bank will survive. Based on the closing price of the Corporation's common stock on January 24, 2017 of $36.46 per share, the transaction value is estimated at approximately $75.8 million. The transaction is expected to be a tax-free stock exchange for Arlington Bank's shareholders who will be receiving the Corporation's common stock pursuant to the merger. Subject to Arlington Bank's shareholders’ approval of the merger, regulatory approvals and other customary closing conditions, the parties anticipate completing the merger in the second quarter of 2017. Arlington Bank's total assets as of December 31, 2016 were $309 million.

Independent Alliance Banks, Inc. Merger

On February 17, 2017, the Corporation and Independent Alliance Banks, Inc., an Indiana corporation ("IALB"), entered into an Agreement and Plan of Reorganization and Merger, pursuant to which IALB will, subject to the terms and conditions of the merger agreement, merge with and into the Corporation, whereupon the separate corporate existence of IALB will cease and the Corporation will survive. Immediately following the merger, IALB's wholly-owned subsidiary, iAB Financial Bank, shall be merged with and into the Bank, with the Bank continuing as the surviving bank. On November 21, 2016, the Corporation purchased 495,112 shares or 12.1% of IALB's outstanding common stock from an IALB shareholder for $19.8 million. Based on the closing price of the Corporation's common stock on February 16, 2017 of $42.10 per share, the transaction value for the remaining shares of common stock, not owned by the Corporation, is approximately $251.3 million. The transaction is expected to be a tax-free stock exchange for IALB's shareholders who will be receiving the Corporation's common stock pursuant to the merger. Subject to IALB's shareholders’ approval of the merger, regulatory approvals and other customary closing conditions, the parties anticipate completing the merger in the third quarter of 2017. IALB's total assets as of December 31, 2016 were $1.1 billion.

103

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

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, 2016, 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, 2016. 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, 2016 is effective based on the specified criteria.

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, 2016, 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 (Corporation) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Corporation'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 financial statements for external purposes in accordance with generally accepted accounting principles. 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 generally accepted accounting principles, 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 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.

In our opinion, First Merchants Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, 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 March 1, 2017, expressed an unqualified opinion thereon.

BKD, LLP

Indianapolis, Indiana

March 1, 2017

ITEM 9B. OTHER INFORMATION

None

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PART III: ITEM 10., ITEM 11., ITEM 12., ITEM 13. AND ITEM 14.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information in the Corporation’s Proxy Statement dated March 21, 2017 to be furnished to its stockholders in connection with an annual meeting to be held May 1, 2017 (the “2017 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 2017 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 2017 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 2017 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 2017 Proxy Statement, under the caption "INDEPENDENT AUDITOR", is expressly incorporated herein by reference.

106

PART IV: ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS

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, 2016 and 2015

Consolidated statements of income, years ended December 31, 2016, 2015 and 2014

Consolidated statements of comprehensive income, years ended December 31, 2016, 2015 and 2014

Consolidated statements of stockholders' equity, years ended December 31, 2016, 2015 and 2014

Consolidated statements of cash flows, years ended December 31, 2016, 2015 and 2014

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:

2.1	Agreement and Plan of Reorganization and Merger among First Merchants Corporation, First Merchants Bank and The Arlington Bank, dated as of January 25, 2017 (Incorporated by reference to registrant's Form 8-K filed on January 25, 2017) (SEC No. 000-17071)
2.2	Voting Agreement, dated January 25, 2017, among First Merchants Corporation and certain shareholders of The Arlington Bank (Incorporated by reference to registrant's Form 8-K filed on January 25, 2017) (SEC No. 000-17071)
2.3	Agreement and Plan of Reorganization and Merger among First Merchants Corporation and Independent Alliance Banks, Inc., dated as of February 17, 2017 (Incorporated by reference to registrant's Form 8-K filed on February 17, 2017) (SEC No. 000-17071)
2.4	Voting Agreement, dated February 17, 2017, among First Merchants Corporation and certain shareholders of Independent Alliance Banks, Inc. (Incorporated by reference to registrant's Form 8-K filed on February 17, 2017) (SEC No. 000-17071)
3.1	First 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)
3.2	Bylaws of First Merchants Corporation, as amended (2)
3.3	First 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)
4.1	First 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)
4.2	Indenture dated as of July 2, 2007 (Incorporated by reference to registrant's Form 8-K filed on July 3, 2007) (SEC No. 000-17071)
4.3	Guarantee 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)
4.4	Form 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)
4.5	First 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)
4.6	Upon 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.
10.1	First Merchants Corporation Senior Management Incentive Compensation Program, dated February 13, 2017 (1)
10.2	First 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)
10.3	First 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)
10.4	First 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)
10.5	First 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)
10.6	First 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)
10.7	First 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)
10.8	First 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)

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PART IV: ITEM 15. FINANCIAL STATEMENT SCHEDULES AND EXHIBITS

10.9	First 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)
10.10	Resolution 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)
10.11	First 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)
10.12	First 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)
10.13	First 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)
10.14	First 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)
10.15	2011 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)
10.16	Stock Purchase Agreement among First Merchants Corporation and Leland Boren as Sellers' Representative, dated September 20, 2016 (Incorporated by reference to registrant's Form 8-K filed on September 26, 2016) (SEC No. 000-17071)
21	Subsidiaries of registrant (2)
23	Consent of Independent Registered Public Accounting Firm (2)
24	Limited Power of Attorney (2)
31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 (2)
31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002 (2)
32	Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2)
99.1	Financial statements and independent registered public accounting firm’s report for First Merchants Corporation 2009 Employee Stock Purchase Plan (2004) (2)
101.INS	XBRL Instance Document (3)
101.SCH	XBRL Taxonomy Extension Schema Document (3)
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document (3)
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document (3)
101.LAB	XBRL Taxonomy Extension Label Linkbase Document (3)
101.PRE	XBRL 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

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 1st day of March, 2017.

FIRST MERCHANTS CORPORATION
By:	/s/ Michael C. Rechin
Michael 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 1st day of March, 2017.

/s/ Michael C. Rechin	/s/ Mark K. Hardwick
Michael C. Rechin, President and	Mark K. Hardwick, Executive Vice President,
Chief Executive Officer	Chief Financial Officer and Chief Operating Officer
(Principal Executive Officer)	(Principal Financial and Accounting Officer)
/s/ Michael R. Becher*	/s/ Michael C. Rechin
Michael R. Becher, Director	Michael C. Rechin, Director
/s/ Michael J. Fisher*	/s/ Charles E. Schalliol*
Michael J. Fisher, Director	Charles E. Schalliol, Director
/s/ F. Howard Halderman*	/s/ Patrick A. Sherman*
F. Howard Halderman, Director	Patrick A. Sherman, Director
/s/ William L. Hoy*	/s/ Terry L. Walker*
William L. Hoy, Director	Terry L. Walker, Director
/s/ Gary J. Lehman*	/s/ Jean L. Wojtowicz*
Gary J. Lehman, Director	Jean 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. Hardwick
Mark K. Hardwick
As Attorney-in-Fact March 1, 2017

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