The Chicago market has loomed on the horizon for First Merchants (FRME), just out of reach of its Muncie, Ind., hub.

Now, the $4.3 billion-asset company is edging close enough to catch a breeze from the Windy City.

First Merchants on Monday said it has agreed to acquire CFS Bancorp (CITZ), a $1.1 billion-asset company in Munster, Ind., for $114.7 million. The all-stock deal is expected to close in the fourth quarter.

With the Chicago banking market still slowly recovering from the financial crisis, the move carries risk. But First Merchants is being careful to stress that it's only acquiring exposure to the far suburbs of Chicago, not the city itself.

"The plan here isn't move into Chicago," says John Barber, an analyst with Keefe, Bruyette & Woods. "They are very cognizant of where their business model makes sense."

CFS operates 20 branches of its Citizens Financial Bank in northwestern Indiana and northeastern Illinois, with offices in the Indiana cities of Crown Point, East Chicago, Hammond and Valparaiso, among others. Many people who live in that area commute to Chicago for work, says Michael Rechin, president and chief executive of First Merchants. But First Merchants plans to focus on growing its commercial and industrial loan book only in the cities where CFS now has branches, he says.

"The reason that [northwest Indiana] has such positive demographics is, they get to feed off the momentum of the Chicago area," says Rechin, whose company operates primarily in central Indiana. "We've watched our company build momentum in that part of the state and see no reason we can't continue to play off of that."

First Merchants was further attracted to CFS because of its deposit book. Core deposits make up about 67% of total deposits, as of March 31.

"That was a big driver," Rechin says. "We always think that's the real value of an organization."

First Merchants is paying 103% of tangible book value, according to the companies. When markdowns of loans to fair value are included, First Merchants would pay a 145% premium to adjustable tangible book value, Rechin says.

First Merchants offered a reasonable price, Barber says. "It compares well to other recent transactions," Barber says.

CFS had struggled with credit issues in recent years, and First Merchants would book $58 million of credit markdowns tied to the deal. CFS had reduced its balance of nonperforming assets, taking chargeoffs totaling $59 million since 2007.

CFS has operated under a formal agreement with the Office of the Comptroller of the Currency since December 2012, requiring it to address credit quality. That enforcement action would be terminated upon First Merchants' closing of this deal, Rechin said during a conference call on Monday to discuss the agreement.

CFS agreed to pay a $4.5 million termination fee to First Merchants if its backs out of the deal.

The deal is the fifth-largest announced this year, according to KBW. It follows a string of deals involving other Indiana banks, including Old National Bancorp's $79.2 million acquisition of Indiana Community Bancorp last year.

PL Capital, an activist investor group based in Naperville, Ill., is the largest shareholder of CFS, with a stake of about 9.7%. John Palmer, a managing principal of PL Capital, was elected to the CFS board in 2010 after PL Capital pursued a proxy battle with management.

Daryl Pomranke was promoted to chief executive in December 2011, from the position of chief operating officer, on the retirement of Thomas Prisby. Robert Ross was named chairman.

Both Pomranke and Dale Clapp, Citizens' executive vice president of sales management, are expected to become executives of First Merchants following completion of the deal. Pomranke would serve as a regional president.

Sandler O'Neill & Partners advised First Merchants and Bingham Greenebaum Doll provided legal advice. River Branch Capital was financial advisor to CFS and Vedder Price served as its legal counsel.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.