First Merchants Corp
NASDAQ:FRME
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First Merchants Corp
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Thank you for standing by, and welcome to First Merchants Corporation's First Quarter 2024 Earnings Conference Call. Before we begin, management would like to remind you that today's call contains forward-looking statements with respect to the future performance and financial condition of First Merchants Corporation that involve risks and uncertainties. Further information is contained within the press release, which we encourage you to review.Additionally, management may refer to non-GAAP, which are intended to supplement but not substitute for the most direct comparable GAAP measures. The press release available on the website contains financial or other quantitive information to be discussed today as well as a reconciliation of GAAP for non-GAAP measures. As a reminder, today's call is being recorded. I would now like to turn the conference over to Mr. Mark Hardwick, Chief Executive Officer.
Thanks for the introduction and recovering the forward-looking statement on Page 2. We released our earnings today at approximately 8:00 a.m. Eastern Time. You can access today's slides by following the link on the third page of our earnings release. On Page 3 of our slides, you will see today's presenters and our bios to include President, Mike Stewart, Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki. On Page 4, we have a few financial highlights for the quarter to include total assets of $18.3 billion, $12.5 billion of total loans, $14.9 billion of total deposits and $8.3 billion of assets under advisement. On Slide 5. If you look at bullet point 1, under our first quarter results, you will note that margin is stabilizing and new and renewed loan yields for the quarter totaled 8.15%. You will also notice on bullet point 5 that we were active during the quarter were purchasing $30 million of shares in First Merchants and redeeming $40 million of sub debt, which recently repriced to just over 9% .On bullet point 6 .We reported first quarter 2024 earnings per share of $0.80 or $0.85 when adjusted for $3.5 million of noncore items incurred during the quarter. On the last bullet point, I would also note that three of our four major technology initiatives were deployed during the first four months of the year to include the rollout of a new in-branch account opening platform called Terafina, our new online and mobile platform for more than 150,000 consumer customers that converted to Q2 and our new private wealth platform converted to SS&C's Trust Platform. As you can imagine, these projects require a significant amount of time and resources and require heightened customer focus during implementation. Now Mike Stewart will discuss our line of business momentum.
I'm on Page 6 and our business strategy remains unchanged. We are a commercially focused organization across all these business segments and across our primary markets of Indiana, Michigan and Ohio. As we enter 2024, we have remained focused on executing our strategic imperatives, organic loan growth, deposit growth, fee growth, attracting, retaining and engaging our team, investing in the digitization of our delivery channels and delivering top-tier financial and risk metrics. If you go to Slide 7, the first quarter continued a choppy trend of loan growth from quarter-to-quarter. I highlighted the 8% annualized loan growth during the fourth quarter of 2023, which followed a relatively flat third quarter of less than 0.5%. The first quarter balance decline in the commercial portfolio was attributed to the seasoning of numerous real estate projects that had stabilized and were refinanced into the secondary market. This is normal course for most construction projects and with the current inverted yield curve, it is advantageous for the client to take advantage of lower long-term fixed interest rates. Commercial balances were also affected by the seasonal nature of our agribusiness clients. John Martin has more detailed information within his portfolio summary, which also highlights the growth within the commercial and industrial portfolio of over 5.5% on an annualized basis during the first quarter. Short-term interest rates have affected the velocity of new investment real estate projects, but we have remained active with well-capitalized projects. The commercial and industrial growth is building as existing clients continue to finance normal course capital expenditures, complete strategic acquisition or as we add market share. Our Michigan commercial banking team has built very good momentum. That's the former Level 1 and Monroe Bank entities and was our strongest region of C&I growth. Our investment in people and our brands are building in Michigan. The third bullet point further emphasizes the future growth potential within our C&I portfolio. The pipeline ended the quarter is strong and the commercial segment will continue to be the primary driver of our asset growth. The consumer portfolio is comprised of residential mortgage, HELOC installment and private banking relationships. During the first quarter, that portfolio declined 0.8% and in dollars, that represented less than $6 million. Our private banking portfolio was the primary driver of that decline as high net worth clients reduced higher cost borrowings with excess liquidity. The overall economic environment in the Midwest, inclusive of the competitive landscape affirms my expectations of mid- to single-digit growth for the balance of the year with improving loan yields. Mark highlighted that our new loan yields exceeded 8% during the quarter, and Michele has more detail to share on those trends. On the bottom half of that page, the quarter saw total deposits growing by 1.7% on an annualized basis. The consumer portfolio grew over $155 million during the quarter and is inclusive of both the branch network and our private banking team's efforts. The branch network continues to deliver the consistent granular low-cost deposit base that we enjoy. The commercial deposit decline during the quarter was primarily from the public fund portfolio as the C&I relationship showed growth. We discussed during last earnings call, both our consumer and commercial teams have been actively managing our interest expense. As we now have separation from the Silicon Valley Bank event last year, our bank's liquidity remains ample , our 2024 efforts will be focused on our margin through interest expense management. As Mark stated in the press release, we are pleased to see our net interest margin stabilizing. Again, as we enter 2024, we're positioned for that continued organic growth. Our continued positioned for that growth and our underwriting remains supportive, consistent and disciplined. I'm going to turn the call over to Michele so she can review in more detail the composition of our balance sheet and the drivers on our income statement.
Slide 8 covers our first quarter results. Pretax pre-provision earnings when adjusted for the noncore charges of $3.5 million that were incurred during the quarter totaled $60.2 million, adjusted pretax pre-provision return on assets was 1.31% and adjusted pretax pre-provision return on equity was 10.75%, all of which continue to reflect strong profitability metrics. To arrive at our core operating results, we excluded charges recorded this quarter, which included $1.1 million for the increased FDIC special assessment and $2.4 million in digital platform conversion costs incurred from the projects Mark covered in his opening remarks. Tangible book value per share increased to $25.07 at March 31, an increase of $2.14 or 9.3% compared to the same period of prior year. Details of our investment portfolio are disclosed on Slide 9. Securities yields increased 2 basis points to 2.58% as lower-yielding securities continue to run on. Expected cash flows from scheduled principal and interest payments and bond maturities in the remaining nine months of 2024 totaled $217 million with a roll-off yield of 2.22%. Slide 10 shows some details on our loan portfolio. The total loan portfolio yield declined 3 basis points quarter-over-quarter, which was simply due to a lower day count. Yields on new and renewed loans continues to increase that yield climbed 140 basis points to 8.15% this quarter compared to 8.01% last quarter. The bottom right shows that 2/3 of our loan portfolio is variable rate. Although some of that is priced at or near our new loan yields, we still have over $1 billion of average earning assets that will be priced from a current weighted average rate of just 5%, which will create some good incremental interest income throughout the remainder of the year. The allowance for credit losses on Slide 11 remained stable compared to last quarter at 1.64% of total loans. We recorded net charge-offs of $2.3 million, which was offset by a provision for credit losses on loans of $2 million, resulting in a reserve at quarter end of $204.7 million. In addition to that, we have $21.8 million of remaining fair value mark on acquired loans. Our coverage ratio when including those marks is 1.82%. Slide 12 shows details of our deposit portfolio. We continue to have a diversified core deposit franchise with a low uninsured deposit percentage. 36% of our deposits yield 5 basis points or less. Our total cost of deposits only increased 6 basis points to 2.64% this quarter, slowing dramatically compared to last quarter where we have experienced an increase of 26 basis points. Our total cost of deposits increased to 2.69% in February and then declined 1 basis point to 2.68% in March due to some price deposit pricing actions that we took during the quarter, which Mike mentioned in his remarks, to reduce deposit costs ahead of the Fed rate cuts. We expect those actions to ensure stability in the cost of deposits next quarter as well as margin. Although we did see a slight decline in noninterest-bearing deposits this quarter, our overall funding mix continued to improve as we reduced broker deposits, wholesale funding and sub debt and grew core consumer and commercial deposits. We paid down $40 million of subdebt at the end of January, and we'll pay down an additional $25 million of sub debt at the end of April. Overall, liquidity is very well positioned to support growth in the coming quarters. On Slide 13, net interest income on a fully tax equivalent basis of $132.9 million declined $3 million from prior quarter. As I mentioned earlier, yield on average earning assets on line 4 was impacted by the number of days in the quarter, yet still increased by 1 basis point. That increase was offset by the increase in funding caused on Line 5, reflecting stated net interest margin on Line 6 of 3.10%, a decline of 6 basis points from prior quarter. Next, Slide 14 shows the details of noninterest income. Overall, noninterest income increased by $200,000 on a linked quarter basis. Customer-related fees declined $1.2 million, reflecting a $900,000 decline on the gain on sales of mortgage loans and lower derivative hedge fees. The first quarter is always a seasonal low for our mortgage business, yet we were encouraged by this quarter's activity because the $3.3 million of gains this quarter included a $500,000 loss on the sale of some nonaccrual loans. Excluding that loss, gains on the sales of mortgage loans would have been $3.7 million, which is a $1.3 million increase over the first quarter of last year. This increase in year-over-year production is what gives us confidence that we will see an increase in noninterest income in the coming quarters. Moving to Slide 15. Noninterest expense for the quarter totaled $96.9 million and as previously mentioned, included $3.5 million in noncore charges. Core noninterest expense beat expectations and totaled $93.4 million, a decrease of $2 million from last quarter's core noninterest expense of $95.4 million. Managing expenses continues to be a point of emphasis for us this year and the results of Q1 demonstrate that commitment. Slide 16 shows our capital ratios. We continue to have a strong capital position with common equity Tier 1 at a robust 11.25%, coupled with a dividend payout ratio of over 40% over the last 12 months. The slight decline in each of the ratios shown reflects the $40 million redemption of subdebt and $30 million of stock buybacks in the quarter. These stock buybacks, coupled with $20 million in dividends paid this quarter provided a great return to our shareholders. These actions reflect our prudent management of excess capital, ensuring top quartile profitability metrics. That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John Martin, to discuss asset quality.
My remarks start on Slide 17. I'll highlight the loan portfolio and touch on the updated insight slides, review asset quality and the nonperforming asset roll forward before turning the call back over to Mark. Turning to Slide 17, where I've highlighted the various portfolio segments. Growth in the commercial and industrial loans on lines 1 and 2 was offset by cooling investment real estate activity. We came off a strong origination quarter at the end of the year, as Mike mentioned, with modest growth in the first quarter, while investment real estate and construction on lines 4 and 5 slowed for the quarter. We continue to hold underwriting standards for new construction opportunities, which is resulting in higher levels of capital required contribution. This, combined with higher borrowing costs has slowed new growth in this segment. Then on Slide 18, the portfolio insights slide helps provide transparency into the portfolio. As mentioned on prior calls, the C&I classification includes sponsor finance as well as owner-occupied CRE associated with the business. Our C&I portfolio has a 20% concentration in manufacturing. Our current line utilization has remained consistent and was up for the quarter at 42% with line commitments lower by $68 million. We participate in roughly $755 million of Shared National Credits across various industries. These are generally relationships where we have access to management and revenue opportunities that go beyond the credit exposure. In sponsored finance portfolio I've highlighted key credit portfolio metrics. There are 86 platform companies with 53 active sponsors in an assortment of industries. 68% of those have a fixed charge coverage ratio greater than 1.5x based on year-end borrower information. This portfolio generally consists of single bank deals for platform companies or private equity firms as opposed to large, widely syndicated leveraged loans traded across banks. We review the individual relationships quarterly for changes in borrower condition, including leverage and cash flow coverage. Turning to Slide 19, where we break out our investment or owner-occupied commercial real estate our office exposure is detailed on the bottom half of the slide and represents 2% of total loans with the highest concentration outside of general office and medical office space. The wheel chart on the bottom right details office portfolio maturities, loans maturing in less than a year, represent 11.3% of the portfolio or $28 million. The office portfolio is well diversified by tenant type and geographic mix. We continue to periodically review our larger office exposures in view the exposure is reasonably mitigated through a combination of loan-to-value guarantees, tenant mix and other considerations. On Slide 20 are the asset quality trends and current position, NPAs and 90 days past due loans increased $11.6 million–$56 million basis points of loans and ORE. All up for the quarter, the change was largely driven by a single $12 million new hospitality-related credit, which we expect to resolve in the third quarter. On line 3, 90-day delinquent loans were up $2.8 million with one borrower comprising $1.2 million for the increase. We view this relationship as well as secured in the process selection. Classified loans ended the quarter at 2.24% of loans, up from 1.94% from the prior quarter. Then down on line 9, net charge-offs were 7 basis points of annualized average loans. Moving to Slide 21, where I've again rolled for the migration of nonperforming loans, charge-offs, ORE and IEA past too .For the quarter, we added nonaccrual loans on line 2 of $17.7 million, driven by the hospitality credit I just mentioned previously, a reduction from payoffs or changes in accrual status of $5.6 million on Line 3 aided by a $2.1 million nonperforming mortgage loan sale and a reduction from gross charge-offs of $3.2 million. Dropping down to Line 11, 90-day delinquent loans increased by $2.6 million, which has resulted in NTA plus 90 days past due ending at $70.2 million for the quarter. Summarizing, asset quality was marginally down in the quarter. Net charge-offs for the quarter were 7 basis points. Nonaccrual to classified loans were marginally higher. I appreciate your attention, and I'll now turn the call back over to Mark Hardwick.
Turning to Slide 22. We saw our track record of shareholder value, and there are a number of really positive trends. I would just highlight one in particular, if you look at the top right-hand portion of the page, we saw our 10-year earnings per share CAGR, and it totals 10.2%. Also, we just have a continued focus on growth of tangible book value per share, and we're proud of these numbers. On Slide 23, it represents our total asset CAGR of 12.6% during the last 10 years and highlights meaningful acquisitions that have materially added to our demographic footprint that help fuel our growth. There are no edits to Slide 24. At this time, I'd like to thank you for your attention and your investment, and we are happy to take questions.
[Operator Instructions] Our first question comes from the line of Damon DelMonte with KBW.
Just wanted to start off with a question on margin for Michele. Can you just give us a little insight as to how you're seeing the cadence over the next few quarters? It sounds you guys are intently focused on reducing the funding component of it, the cost of funding related to the margin and with new loan production coming on at rates that are over 8%. Just wondering how you're thinking about the margin at this point?
Our quarterly margin for Q1 was 310. In March, our margin was 311. It actually picked up a basis point. The reason why we have some optimism around it. I think it's one of the things that you just stated and so we do believe that margin will be stable next quarter and then potentially even growing, depending on how the market fares through the remainder of the year.
Can you just remind us if there are rate cuts in the back half of the year? What's your anticipation or a 25 basis point cut?
Our models tell us that each 25 basis point cuts that our margin declined 3 basis points. The actions that we're taking to try to manage our funding cost to hopefully reduce some of that impact, but that is what our model, given that we have asset sensitivity.
Then with regards to the outlook for loan growth, I think Mike said that he's still optimistic in the -- was it mid-single or mid- to high single digits after first quarter's results?
Mid to high singles should feel good, especially given where we are already through April and I try to highlight that the C&I growth is really strong right now, but the continued maturity of the real estate project. Overall, yes, mid-single high for the year.
Then just lastly on capital management. I think you guys did $30 million of buybacks this quarter. I guess, first, how much buyback is remaining under the current authorization? What's your thoughts on additional appetite going forward?
We're around $45 million remaining and continue to be active. It's going to be a meaningful part of our May 7 board meeting just sharing capital planning and thinking about future. We're convinced that if our stock price is going to continue to trade at I guess, multiples that are sub-10 when we historically have traded 12–13, we feel like it's prudent to be active with buybacks. Our tangible common equity continues to be above 8% and all of the other capital ratios are well above our target. In this environment, we feel like it's the right prudent call to make.
Our next question will come from the line of Nathan Race with Piper Sandler.
Wanted to clear by on the margin commentary to the earlier question, that 3 basis points or so of impact to the downside, that's not under a static rate environment that doesn't necessarily contemplate continued redeployment of excess liquidity coming off the bond book in the loans. Is that correct?
It always contemplate us using that excess liquidity into new assets.
Then just on fee income. I think last quarter, we're talking about a run rate of around 30 years or so per quarter. Is that still a reasonable expectation going forward?
Yes. I actually expect us to maybe just a touch lower, maybe more 20%, 29% per quarter. Last quarter, when we provided that guidance that was largely based on the fact that we expected more rate cuts during the year. Whenever we do get rate cuts that really invigorates our mortgage business and so gaining on sale of mortgage loans higher. Given that we're expecting less rate cuts at this point and probably adjust that down slightly.
Then just turning to expenses. I think last quarter, we were talking about 0%–2% growth off the 4Q annualized level. Is that still a good process to use going forward for 2024?
I think our expenses can offset a little bit of the reduction of noninterest income that I just talked about. We had a really good expensive quarter. I would expect to churn a little lower than the guidance that we provided. We will have some additional digital platform conversion cost in Q2, just as a reminder, that should run about $2.5 million. That will be on top of that core run rate.
Then just turning to credit quality, it doesn't sound like there was any major surprises in terms of the rise and classified and nonaccrual. John, is it fair to assume that you're not seeing any system across the portfolio. It's more so just ongoing normalization at the broader industry is encountering these days? Just how you think about charge-off levels going forward?
I do look at it as a return to more of a normalized credit environment. The charge-off rate, I think we said last quarter, we've come under it in the last couple of quarters, but I think about it in that 15–20 basis point range.
Then assuming a stable macro environment, I know it's a flow situation under CECL. To what extent do you see a need to provide mid- to high 12-digit growth just given that your reserve is still solidly above peers?
I think where our coverage ratio is today is largely where we would, assuming the economic scenarios don't change again. I think we would want to keep our coverage ratio somewhere within where it's at today to cover for any new growth and any charge-offs.
Our next question will come from the line of Brian Martin with Janney Montgomery Scott.
Michele I just wanted to ask you, you talked about taking some asset on the deposit side to help on the funding cost. Can you just elaborate on what you did? I guess is there more of that to come? Is that done at this point? Given focus on managing the funding cost?
Brian, yes, we've actually just had our asset and liability committee meeting yesterday and walked through every line of business, consumer, commercial, private wealth and are continuing to look at strategies really across the board where we can make modest trade production that we think takes some of the pressure of. We're not doing anything in a really big way, we're not making 25 basis point reduction. We're finding ways to pick up 5 basis points in a number of different places that we think get ahead of a rate reduction and continue to allow us to have a really healthy liquidity position at the right price.
There's a little bit more on that, it's not ongoing. You're not merging to do it incremental along the way to pick that up.
Yes, that's correct.
You talked about this particular strength in C&I this quarter. Anything special driving that? I guess you believe it's sustainable?
I do believe it's sustainable. Couple of other drivers will be investments that we've done, we mentioned the new markets, the new markets that we have had use level 1, a couple of years ago. The team, the brand, reaching out to the market, taking advantage of the other competitive landscape there. We pay dividends. Generally, C&I, corporate executives still feel good about their businesses. They are investing, again, whether it's plant equipment. We're doing some strategic acquisitions. We play really well into that space. Again, probably the fact that the Midwest feels pretty insular to the other headwinds that cost might have and look pretty active.
Noninterest-bearing deposit trend, I think you talked about down a little bit this quarter. I guess, do those feel like they're beginning to stabilize? Then secondly, you also talked about some further redemption of some sub debt, net other $25 million. Is it still the plan on that in Q2 or?
Yes, Brian, we are paying down the remaining $25 million at the end of this month. I didn't catch the first part of your question.
The noninterest-bearing deposit trend. I know they were down a little bit this quarter, but just beginning to see those stabilize. Is that what you're seeing underneath?
We would expect the decline in that to moderate. We need a little bit more compression there, but it's largely going to start to tail off, I think.
Our next question comes from the line of Daniel Tamayo with Raymond James.
I guess most of my questions have been asked already, but a couple of cleanup questions. First, I guess, John, on the classifieds, if you can provide a little more detail on where the increase came from, if it was C&I or CRE, what you're seeing there?
I'd say it was probably 2/3 C&I, 1/3 CRE combination of different types of asset classes within the CRE and across the industry within the C&I. I would describe it as normal inflows and outflows with individual issues with P&I borrowers and just addressing issues as it relates to CRE. Higher interest rates had an impact on CRE and as much of the conversion tests that are more challenging. We're just addressing those.
Then I don't know if I missed this or not, but did you provide or do you have the amount of the office loans that are in central business districts?
I don't have it by central business district. I've got a split within that slide about as granular by habit. I think it is on Slide 18, maybe. Slide 19. With the breakdown of tenant and geography. I will say that anecdotally, and when I think about that office portfolio, we're not a central business district type lender of downtown Indianapolis or Chicago or something or mostly suburban related to developers who have done projects await from the main business history.
Then just quickly on deposit expectations, obviously, there's a lot of moving parts there, but do you expect to fill the gap on the funding side to keep the loan-to-deposit ratio similar to where it is now, given your loan growth?
We have a desire to see the loan deposit ratio tick up slightly. It's a fun time in the business. Honestly, we're actively pursuing new client relationships on the lending side. We expect to have mid- to high single-digit growth. It feels like we're getting back to what would be more of a historical level where you tend to grow loans in the mid- to high single digits and deposits in the mid- to low single digits. I think it creates a little more efficient and effective operating model.
Our next question comes from the line of Terence McEvoy.
Michele, you mentioned $1 billion of repricing. Was that specifically out of the loan portfolio over the next three quarters coming out of the 34% of the portfolio that's fixed today.
It's mostly on the loan portfolio, yes. It's a total earning asset number. It will also include the securities that are going to be maturing as well, but it is mostly loan. It's the mix of those that are fixed as well as the variable
Then just taking into consideration your loan growth commentary, deposit cost and margin, it sounds like net interest income bottomed in the first quarter and should grow from here. Would you agree with that, Michele?
I would think so. The guidance that we gave on our outlook last quarter was that we saw the second quarter will stabilize, and then we see some growth in the back half of the year. I think that's largely what our expectation is.
When I look at the largest component of nonowner-occupied CRE it's multifamily. Do you have any comments on vacancy trends, new supply, rent growth, particularly within some of those larger metro markets in Indiana and Michigan.
Yes. We're still seeing rent growth, but it has slowed. It's tapered from what was a break deck fee earlier in the cycle to a more modest level. Really the multifamily that we have, as Mike mentioned earlier, been able to stabilize and move to the permanent market. We still feel pretty good about that to say, although obviously, new opportunities are going to get more challenging with higher rates.
I'm currently showing no further questions at this time. I'd like to turn the call back over to Mr. Mark Hardwick for closing comments.
Yes, I really don't have much other than just, again, an expression of our appreciation for your interest in our company and the continued investment. The teams are working hard to deliver our results for the remainder of the year. Thank you again for your attention.
This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.