First Merchants Corp
NASDAQ:FRME
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First Merchants Corp
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Good day, and welcome to the First Merchants Corporation Second Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.
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 measures, which are intended to supplement but not substitute for the most directly comparable GAAP measures. The press release available on the Web site contains financial and other quantitative information to be discussed today, as well as reconciliation of GAAP to non-GAAP measures.
I would now like to turn the conference over to Mark Hardwick, CEO. Please go ahead.
Good afternoon, and welcome to the First Merchants second quarter 2021 conference call. We released our earnings today at approximately 8.00 AM Eastern Time. Hopefully, you have all found your way to our slide presentation. But if not, you can access the slides by following the link on the second page of the earnings release. Betsy, thanks for the introduction and for covering the forward-looking statement on Page 2.
On Page 3, you will see today's presenters and bios to include President, Mike Stewart; Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki.
Page 4 is a nice one page snapshot of First Merchants geographic footprint and a few relevant financial highlights for your review. We feel our year-to-date return on assets of 1.45% and return on tangible common equity of 16.82% reflect the strength of First Merchants overall balance sheet and earnings model.
Now if you would turn to Slide 5. As my quote in the press release states, we are pleased with our record setting second quarter net income totaling $55.6 million and earnings per share of $1.03 per share. In addition to earning $105 million and $1.94 in earnings per share during the first six months of the year, we've consolidated 17 banking centers and fully integrated our Hoosier Trust Company acquisition.
Mike Stewart will now provide some color on our strong balance sheet growth to include our second quarter loan growth of 6.7%.
Thank you, Mark, and good afternoon. As you look at the next two slides, I want to provide an update on our line of business results and their contributions within the quarter. Michele and John's comments on slides will provide you greater detail. And since nothing has changed with our strategy in key lines of business, which is Page 6, I want to focus on Page 7, the line of business balance sheet highlights.
On the top of the page offers a breakdown of the core loan growth by our business units. All these percentages exclude the balances of the PPP loans. The private wealth and consumer groups grew at 4% and 5%, respectively. As talked about last quarter, our private wealth team is now fully integrated into each of our markets and their connectivity with the commercial team continues to drive our growth in PWA relationships and the loan activity.
Our consumer loan balances grew in the quarter based on increases in origination, both in units and dollars, over the prior quarter. The growth was further augmented by a slight increase in HELOC utilization moving from 40% to 41% in the quarter. This is the first increase in organic growth the consumer group has experienced in five quarters.
As noted on top of the page, we chose to sell 76 million of the longer term fixed rate on balance sheet mortgage loans. During the quarter, we experienced an increase of construction and purchase volumes, which will position the balance sheet for growth over the next several quarters. And the pipeline for mortgage originations remains strong at the end of June. And with the recent decline of the 10-year treasury rates, refinance volumes should increase.
Our core non-PPP commercial loans grew in the quarter 14% on an annualized basis. The growth was a result of several factors, but primarily the strong pull through of the pipeline as of the end of March. Post round two of PPP, the economic and business climate and all of our markets have been good. We have previously discussed the decreasing line of credit utilization rates, which increased this quarter by approximately 1%.
With PPP in the rearview mirror, businesses have been active in financing new plant and equipment for their growth, new acquisitions have kept pace and the growth in working capital has improved. Our investment in growing our commercial banking team across all the markets continued to drive new client conversion. All of our commercial bankers remained engaged with and prepared for the capital needs of businesses as they outwork our competition.
In summary, after adjusting for PPP, the 76 million mortgage portfolio sale, organic growth for the second quarter was 10%. The pipeline looks to be able to deliver continued growth in subsequent quarters and affirms my expectation on mid-to-high single digit annual growth rates over time.
A few comments on deposit growth for the quarter. Overall, deposit balances grew around 8%. The growth of the commercial deposit base of nearly 30% outpaced the decline of the consumer deposits, but both segments were primarily influenced by the various economic stimulus programs. Consumers were net users of prior quarters’ economic impact payments, and municipalities and other public institutions like universities were net recipients of stimulus dollars throughout the quarter.
As Michele will highlight next, our deposit costs continue to decline again in the quarter being nearly equally shared between the consumer and commercial business units. The map you see on Page 7 represents the demographics of the growing economic environment, the heart of the Midwest, that drives our growth and a stable source of talent to lead our business efforts across all lines of businesses.
Over the past quarter, I've continued to visit these markets and I’ve witnessed the reemergence and acceleration of business activities by both our bankers and our communities. And I believe this business climate remains good.
I will now turn the call over to Michele, who will provide the complete review of the quarter results and operating metrics before John shares the soundness of our portfolio.
Thanks, Mike. My comments will begin on Slide 8. We had meaningful balance sheet growth during the quarter, which you can see on lines one through four, as total assets increased 294 million or 8%.
The deposit growth of 252 million coupled with PPP loan forgiveness created liquidity of over 600 million, of which 290 million was used to fund the loan growth and the remaining liquidity was invested in the bond portfolio.
We are pleased to report net income on line 17 increased 6 million or 12% over first quarter, which is a 49% increase when annualized, leading us to earnings per share of $1.03 shown on line 22. This result led to an outstanding efficiency ratio for the quarter of 48.91%.
On line 23, you will see the tangible book value per share increased by $1.17 from first quarter due primarily to the exceptional core earnings contribution this quarter, and also an increase in unrealized gains in the investment portfolio.
Moving up to line 19, return on average equity increased 1.29% to 12.04%. Pre-tax, pre-provision return on average equity was a strong 14.27% reflecting pre-tax, pre-provision earnings of 65.9 million, an increase of 7.4 million over prior quarter.
Slide 9 shows our year-to-date results. Line 22 shows year-to-date earnings per share of $1.94, a $0.70 increase over the same period in the prior year. The efficiency ratio for the first half of 2021 is an outstanding 49.54%.
Slide 10 shows the highlights of our investment portfolio. The top right graph shows the trend in the portfolio yield. The yield on the portfolio declined 11 basis points during the quarter due to the rate environment.
However, the portfolio contributed 24 million of interest income on a fully tax equivalent basis this quarter, an increase of 1.6 million over prior quarter and the overall portfolio yield continues to outpace that of peers. We continue to invest excess liquidity in the investment portfolio and have enjoyed meaningful incremental earnings that have come with that decision.
In the middle right of Slide 10, the net unrealized gain is noted which is at 131.7 million at the end of Q2. This is up 46.4 million in Q1 contributing capital through accumulated other comprehensive income as a component of equity. Net unrealized gains as of today is even higher at 160 million.
The current tax equivalent purchase yield noted in the bottom left is approximately 2%. We've been able to maintain excellent credit quality of the portfolio with AA rated securities and have not extended the duration of the portfolio this quarter even though we had significant growth.
On Slide 11, in the bottom left corner, you will see the second quarter loan yield was a strong 4.05%. Excluding the impact of PPP loans, loan yield was 3.78%. Yield on new and renewed loans in the fourth quarter averaged 3.27%, down 36 basis points from the yield on new and renewed loans from last quarter, which fluctuates depending on growth mix.
On the bottom right is the loan rate structure which shows that 64% of the loan portfolio is variable and 36% is fixed, with 5% of the fixed rate loans being PPP loans. Excluding the PPP loans, 67% of our portfolio is variable rate, which allows us to maintain an asset sensitive balance sheet.
Slide 12 shows the details related to our allowance for credit losses on loans. On the bottom left of the slide is a roll forward of our allowance balance. During the quarter, we had 1.7 million in charge-offs and recoveries of 400,000, which on a net basis reduced the allowance balance modestly and we did not book any provision expense this quarter. Therefore, the ending allowance for credit losses on loans was 199,775,000.
The coverage ratio trend is shown on the graph on the top left. Our coverage ratio at the end of Q2 is 2.19%, up from 2.16% from the prior quarter. But excluding PPP loans, the coverage ratio is 2.29%, down from 2.34% last quarter.
Now I will move to Slide 13. On the bottom left, you will see the cost of deposits continues its downward trend to 19 basis points in the second quarter. This is a 2-basis point decline from the prior quarter and 28-basis point decline from Q2 2020. Our company generated average deposit balance growth of 557 million on a linked quarter basis. Yet interest expense from deposits declined 400,000 due to the continued deposit pricing discipline.
Slide 14 shows the trending of our net interest margin. Line one shows net interest income on a fully tax equivalent basis of 109.2 million. When you back out non-core interest income items, such as fair value accretion on line two and the impact of PPP loans shown on line three, our core net interest income totals 97 million compared to the prior quarter total of 94.1 million, the increase in core net interest income was 2.9 million.
Stated net interest margin on line six was stable and totaled 3.22% for the quarter. Adjusting for fair value accretion and the impact of PPP loans brings us to a core net interest margin of 3%, which is only 4 basis points lower than the first quarter NIM of 3.04%.
On Slide 15, non-interest income totaled 30.9 million for the quarter, with total customer related fees of 26.9 million. The quarter-over-quarter increase was due to gains on the sale of loans of 4.3 million, 2.9 million of which was from the $76 million sale of portfolio mortgage loans. Also wealth management fees increased 1.1 million, reflecting the addition of 400,000 in fees from the Hoosier Trust acquisition and tax preparation fees that are collected annually of 500,000.
Moving to Slide 16. Total expenses for the quarter totaled 69.3 million, which was 3.2 million more than Q1 expenses of 66.1 million. In the bar graph on the far right, you will see the increase in salaries and benefits driven by higher salary expense and incentive accruals booked during the quarter.
Slide 17 shows the strength of our capital ratios. The tangible common equity ratio at the top of the page is stated at 9.04%, but is 9.10% without the impact of PPP loans. As a reminder, the large decline from Q4 2020 to Q1 2021 reflected a 45 basis point impact from CECL adoption. At the bottom, you will see common equity Tier 1 ratio and the total risk-based capital ratio remain at very high levels reflecting the strength of our capital base.
That concludes my remarks. And I will now turn it over to our Chief Credit Officer, John Martin.
Thanks, Michele. My comments start with Slide 18. I will review the loan portfolio including industry concentrations, the PPP loan program, provide an asset quality update, including the remaining COVID deferrals, and then close with an asset quality roll forward, including a few high level comments before turning the call back over to Mark.
So turning to Slide 18. For the quarter, the portfolio experienced strong loan growth as Mike Stewart mentioned in his earlier remarks. Total loans grew $143 million when factoring in the $352 million in expected PPP loan forgiveness in the quarter.
When excluding the changes in the PPP loans and the mortgage portfolio loan sale that Michele just mentioned, the organic loan growth was 10% annualized led by the investment real estate portfolio that I have labeled CRE non-owner occupied on line five, the public finance portfolio on line seven and the sponsor finance portfolio on line two.
We also had an additional $20 million in PPP loan originations in the quarter and ended it with $416 million in balances to 3,239 borrowers with $13.6 million in remaining unearned fees. Mortgage loan production remains strong in the quarter.
Our mortgage banking business is customer-centric, focused on our retail customers and commercial relationships through our private banking business. We operate a mostly originate and sell model, as Mike Stewart highlighted above.
We decided to take advantage of the current environment to sell an additional $76 million of portfolio loans above our normal origination volume. This sale in addition to normal attrition through refinance and repayment resulted in the decline in mortgage footings on line nine.
We continue to evaluate such opportunities as we continue through the year. The core commercial portfolio remains diversified and balanced with a skew towards manufacturing centered in our geographies with core scalable business lines leading our growth. We continue to have a well balanced, commercially oriented C&I and investment real estate portfolio that resembles the markets we serve.
Slide 19 highlights our asset quality. Our trends continue to be stable to improving with NPAs plus 90 days past due on line five, down $1.3 million. This left NPAs plus 90 days past due two loans plus ORE unchanged at 65 basis points.
Classified loans on line seven, defined as those with a well defined weakness, continue to decline this quarter, down $64 million or 25.8%. This change in classified loans primarily resulted from several larger names being either upgraded or exited from the portfolio. Net charge-offs on line nine were down for the quarter $1.3 million, 6 basis points of average annualized loans.
Finally at the bottom of this slide, I highlight the remaining COVID deferrals. These continue to decline as the borrower's deferment periods end, and it's expected that most all of these remaining deferrals will end in the third and fourth quarter.
In summary, asset quality remained stable and somewhat improved, really improving. And while the operating environment beyond the pandemic continues to remain challenging for some borrowers, they have been able to adjust to face these challenges.
The portfolio continues to trend in the right direction with the help of the PPP program and an improved economic environment. This has led to better overall borrower financial performance and improvement in the residual pandemic and impacted portfolios.
Then finishing up on Slide 20, I've again included the asset quality roll forward, which reconciles changes in asset quality. On lines two and three, we have been able to resolve non-accruals at a pace where the inflows on line two match the outflows on line three, less the $1.7 million in gross charge-offs.
Dropping down to line 11, we saw declines in the 90 days past due loans and renegotiated loans on line 12, resulting in NPAs plus 90 days past due down $1.3 million for the quarter. Thank you for your attention.
And I'll turn the call back over to our CEO, Mark Hardwick. Mark?
Thank you, John. Slides 21 and 22 will highlight our track record of performance. On Slide 23 is a document that highlights our priorities for the next several years of our journey. We are making strides across these goals. And I will formally share more detailed progress at year end. But I couldn't be more pleased with our energy level around making First Merchants the bank of choice throughout our markets.
We chose a balanced approach to meeting the needs of our customers while protecting the health of our teammates over the last 15 months. And just as a reminder, we were in the office in the first quarter of 2020. We were working remotely, drive-thru only or by appointment in the second quarter of last year.
But then back in the office in the third quarter, all the way until the Thanksgiving break where we had to go back to a remote environment, drive-thru only or appointment. And then we were back in the office again fairly early in February. And so I only bring that up to say, I feel like we really have momentum. And we feel like we've delivered a really strong quarter. And we're excited for what's next, and we're having fun.
So I guess with that, Betsy, I'd love to open it up for questions at this time.
We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Scott Siefers with Piper Sandler. Please go ahead.
Good afternoon, guys. Thanks for taking the question. Let's see, I think you had talked about utilization being up about 1 percentage point sequentially. Where is that number now? And what do you guys consider a typical utilization rate?
Hang on, Scott. I think John’s triangulating that.
Yes. Hi, Scott. It’s John. So we've got -- it kind of hit, call it a 37%, 38% at its low. It's been bobbing around 38%, 39% with -- last quarter, it ended like 37%. It's at like 38% now. It got to a high pre-pandemic of like 47.5%. And the pandemic really led to significant declines from peak to trough. We've added through that same time period commitments from, call it, $2.4 billion, up another $300 million, $400 million. So we've got two things happening there. Utilization rates fell, but it's also the result of just increased lines. But this quarter, we added an additional, call it, I don't know, it looks like about $100 million of availability. And yet, we still got an extra 1% of outstanding utilization out of it. So good movement in the C&I loans.
Okay. Perfect. Thank you. And then you mentioned in your prepared remarks that a lot of the loan growth you're seeing is coming from commercial real estate. And are these projects that were delayed during the pandemic or is this new growth, just trying to get a feel for some of the underlying trends there?
Well, a couple of things. It’s Mike Stewart here. On Page 7, I would attribute a lot of the commercial growth and outstanding coming from the C&I portfolio and some of the public finance that we're doing. The real estate also grew as well, but the biggest growth came from those two. The construction portfolio, it’s seasonal. So we've been active in the commercial real estate segment, predominantly multifamily. Think about student housing still been inactive along with industrial warehouse. I see here in the second quarter construction, weather looks good. So it starts to fund those up.
Perfect. Okay. Thank you. Then final one maybe just sort of ticky-tacky question. I think you guys said about $13.6 million [indiscernible] correctly?
That’s correct.
Okay. Perfect. All right, that's it for me. Thank you guys very much.
Thank you, Scott.
The next question comes from Daniel Tamayo with Raymond James. Please go ahead.
Good afternoon, everyone. I just wanted to see if I could get your updated expectations for where that core NIM that sits right at 3% now would have moved going forward?
Hi, Daniel. We do expect core NIM to be under some modest pressure due to excess liquidity and the growth we've had in our securities portfolio. But we feel good about our loan and deposit pricing. And we also expect net interest income to continue to grow next quarter.
All right, terrific. And what are your assumptions within that for any deployment of excess liquidity that you have right now? What are those levels if you can give those as well?
Well, we're expecting the buy yield to stay around 2%. And in terms of the amount that we would expect to invest in the bond portfolio will really just be dependent on what we see in deposit growth. As Mike Stewart said, we are seeing inflows of stimulus money into public entities. So that will probably be the biggest variable.
Okay. All right. That's great. I appreciate you taking my questions.
Thank you, Daniel.
The next question comes from Damon DelMonte with KBW. Please go ahead.
Hi. Good afternoon, everyone. Hope everybody's doing well today. So my first question, just wanted to touch on expenses to start off. Michele, I was hoping you can give a little color on your outlook? And I noticed that salaries and employee benefits are up this quarter. Is that a reasonable level to continue at or there's maybe some one-time items this quarter?
I do think that's a reasonable level. So we're sticking with the expense guidance of 68 million to 70 million each quarter.
Okay. All right, great. And then with respect to the provision outlook and just given the strong underlying credit trends, this is the second quarter in a row where there was no provision. And is it reasonable to assume that we could see that trend continue through the back half of the year?
We have a bias not to take negative provision. We prefer to allow our coverage ratio to come down with our normal levels of loan growth and normal levels of charge-offs. That being said, we'll have to keep an eye on the unemployment rate and see what our forecast comes out. But that does kind of give you our bias.
Okay. Fair enough. That's all that I had. Thank you very much.
Thank you, Damon.
The next question comes from Terry McEvoy with Stephens. Please go ahead.
Hi. Good afternoon, everyone.
Hi, Terry.
So the new loan yields coming down in the quarter definitely caught my eye. And I think I forget who mentioned that it was kind of a reflection of a mix shift. As I look at the top of Page 18 where loans were growing, I hope you could just maybe expand on what the mix shift -- how the mix shift impacted the new loan yields last quarter?
Yes, the mix. So when you think about the sponsor, that's a traditionally wider spread book of business. The public finance is not a widespread. That's a lower spread business. When you think about the investment in people I’ve been talking about across our markets, that's been inside what I would characterize for us is upper middle market. And when you compete in that space, it's a little bit of a thinner spread, when we're getting into leveraging our recently deployed capital markets capabilities and syndication. So that's how I think how that mix plays out in yield.
Thanks. And then as a follow up, the strong growth in the commercial group, specifically C&I, I was wondering does a specific industry standout, any specific region that was behind that group? Maybe expand if you could on the strong C&I growth? Thank you.
It's pretty balanced. I will say that the investment in those bankers that we've been talking about continuing across all of our markets is paying dividends, right. So we put two new people -- well, three new people in our greater Ohio marketplace. So we're seeing some nice growth coming out there. And then Indiana, Indianapolis in particular continues, where we've added additional two bankers in our [indiscernible] middle market. Michigan market, same way there. New banker up there driving some loan growth. And in our specialty business lines, we've added two asset-based lenders and another sponsor banker. So it’s coming in that segment as well.
Great. I appreciate that. Thank you.
Thank you, Terry.
[Operator Instructions]. The next question comes from Brian Martin with Janney Montgomery. Please go ahead.
Hi, guys. Thanks for taking the question. Just one or two from me. Just back to the utilization rates for just a minute, I guess is your -- some of your competitors or just other banks that maybe that's not picking up as much as maybe you guys are seeing a little bit of a pickup here? I guess do you expect that to continue to trend up or does it kind of feel like it's going to be a slow grind up? Just your thoughts on utilization?
Yes. Brian, this is John. I would say that it's probably going to be a slow grind up. They've got to burn through the liquidity that they have on their balance sheet in order to begin to fully utilize the lines. But the request for line availability even through the pandemic continued to be -- continued its trend upwards, which would speak to an expectation that they're going to use the lines ultimately. That's kind of how we think about it. So I would say, as economic activity -- their economic activity continues to pick up, I would fully expect to see that trend upward. And while we don't get into the monthly results, they were up in the interim and were down a little bit at the end. So it's bouncing around month-to-month. And from point-to-point March to June, you see that 1% improvement. So, it's hard to say but I would expect a grind upwards.
Yes. Okay. I appreciate it, John. And then just the last too was just on the forgiveness, just your thoughts on the trend there. I guess do you expect most of that forgiveness to occur? I don't know if you stopped forgiveness of round two this quarter, but just most of that occurs by the end of the year. Is that kind of your thinking today based on the trends?
Brian, for -- and to give you a couple of numbers, we're about 86% of the count from the first round or 88% of the dollars. You think about that. And then you think about round two, we've got 13% of the count and 5% of the dollars. So if you think about what happened last year versus kind of the same point, maybe even more so in this year, as compared to the first round, you'll probably start to see that pick up with comparable forgiveness in 2021.
Got you. Okay. That’s helpful with the numbers. And then maybe just, I don’t know, one for whomever, just on kind of the outlook of capital deployment today. Given the strong earnings this quarter and just kind of the outlook being positive, just kind of wondering how you're thinking about the deployment outside of kind of the organic growth? Maybe just from an M&A perspective, I know it's something you guys have talked about as part of your core strategy. But can you talk about that, that'd be great? Thank you.
Yes, I'll tackle that real quickly. Our strategy is still the same. We think of our capital in thirds [ph]. We're kind of at our payout ratio level that we like. When you think about the share repurchase program, what Michele I think we've repurchased this quarter, $9 million and we have $100 million share repurchase plan on the shelf. We didn't have any repurchases through the first six months. So when I say this quarter, the 9 million, all happened just since July 1. And so we've had some success, taking advantage of lower prices. And then the cash and acquisitions is something that we're always interested in. And as we continue to look at our opportunities, we're making sure that cash is a significant part of that transaction. And Mike Stewart’s done a very nice job of utilizing capital as we grow organically. So, I'm not sure anything has really changed and we do have a goal of staying, or keeping our TC at 9, which we're doing a nice job of, and it produces returns on tangible that are 16% or so, and we think that's a strong number that should get the attention of investors.
Perfect. Okay. Thank you for taking the questions.
Thank you, Brian.
This includes our question-and-answer session. I would like to turn the conference back over to Mark Hardwick for any closing remarks.
Well, just wanted to say thank you for all of the participation and the investment in First Merchants. And like I said, we feel like we delivered a strong quarter. And it's a great reflection of the momentum that we have. So, again, we're appreciative and excited about the year to come. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.