First Merchants Corp
NASDAQ:FRME
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First Merchants Corp
Earnings Call Analysis
Q3-2023 Analysis
First Merchants Corp
As we review the performance at First Merchants for the third quarter of 2023, we can take both pride and caution from several key indicators. The earnings per share decreased from the previous year, from $1.08 to $0.94, reflecting challenges but still achieving a robust return on tangible common equity of 16.54% and a return on assets of 1.24%. Deposits showed resilience, growing by 1.8%, and in particular, core deposits increased significantly when accounting for decreases in brokered and municipal deposits, suggesting a solid traditional customer base. Despite headwinds from customer fraud leading to charge-offs, year-to-date earnings reached $179.9 million, with a guidance of maintaining mid- to high single-digit loan growth and sustaining top quartile performance metrics.
Our strategic focus remains unchanged, emphasizing organic growth across loans, deposits, and fee income, while also fostering team development and enhancing technology platforms. Indicators show loan portfolio growth at 4.6% year-to-date when adjusted, and a bullish view is supported by the highest commercial loan pipeline seen in the past year. We expect to sustain single-digit loan growth with improvements in loan yields into 2024, driven predominantly by the commercial sector.
On the deposit side, we have witnessed notable growth at an annualized rate of 1.8% for the third quarter and 2.4% year-to-date. Importantly, excluding the expected seasonal decline in municipal deposits, commercial-related deposit bases actually expanded by 5%, and consumer deposits surged by over 9% annualized. These trends, coupled with overall balance sheet strength and a disciplined approach to underwriting, place us in good stead for focused growth in the future.
Profitability metrics remain strong with this quarter's pretax pre-provision earnings at $67.4 million, reflecting a tangible common equity ratio uptick from the previous year to 7.69%, and an increase in tangible book value by $3.17. These figures demonstrated our capacity to effectively leverage our assets and grow equity for shareholders while the business expanded by $627 million in loans funded by deposit growth and investment portfolio cash flows.
New loan yields are on an upward trajectory, increasing by 58 basis points to 7.88% this quarter. A majority of our portfolio loans are variable rate, which bodes well for incremental interest income as rates rise. In terms of credit quality, although we've faced some setbacks due to fraud, our overall asset quality remains commendable, with classified loans reduced and non-performing assets also showing a decrease, indicating a generally healthy portfolio and solid underwriting standards.
Looking ahead, management has shown interest in stock buybacks contingent on achieving a tangible common equity level above 8%, but emphasizes that current priorities lie with internal projects, particularly in expanding technology infrastructure. This focus aims to bolster service quality without disregarding market conditions that could affect capital decisions, such as volatility and pricing power related to acquisitions.
Outside an isolated fraud incident, the credit quality has been strong. Provision expenses are anticipated to balance charge-offs with potential releases in the allowance for credit losses. Charge-offs are expected to remain between 10 and 20 basis points quarterly, which underscores the confidence in the credit risk management and the strength of the loan portfolio.
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Thank you for standing by, and welcome to the First Merchants Corporation Third Quarter 2023 Earnings Conference Call. Before we begin, management would like to remind you today's call contains forward-looking statements with respect to future performance and financial conditions 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 most directly comparable GAAP measures. The press release available on the website contains financial and unquantitative information to be discussed today as well as reconciliation of GAAP to non-GAAP measures.[Operator Instructions] As a reminder, today's call is being recorded. I will now turn the conference over to your host, Mr. Mark Hardwick, CEO. Mr. Hardwick, you may begin.
Good morning, and welcome to First Merchants Third Quarter 2023 Conference call. Valerie, thanks for the introduction and for covering the forward-looking statement on Page 2.We released our earnings today at approximately 8:00 a.m. Eastern Standard Time. You can access today's slides by following the link on the third page of our earnings release.On Page 3, you'll 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, you will see a map representing the geographic locations of our 118 banking centers as well as a few financial highlights as of 9/30, 2023. We also received 2 more comparably awards during the quarter, including Best Places to Work for Career Growth and Best Places to Work for Women, which I'm really proud of. So we did include those on Page 4.Now turning to Slide 5. I'm pleased to report that our performance remains healthy and strong, and our teams continue to meet the demands of our communities and our client base. We reported Q3 2023 earnings per share of $0.94 per share compared to $1.08 per share in the third quarter of 2022. Net income totaled $55.9 million for the quarter, producing a return on tangible common equity of 16.54% and a return on assets of 1.24% for the quarter.During the quarter, our deposits increased by $65.4 million or 1.8%. The core results were even better as we decreased brokered deposits by $133.6 million and municipal deposits by $128.8 million. The adjusted growth of $327.8 million in traditional commercial and consumer deposits was very strong and positions us as well for the coming quarters and expected growth.Loan yields remained strong, reflecting a highly variable portfolio, increasing to 6.58%. New and renewed loan yields totaled 7.88%, up 58 basis points over the second quarter of this year. Our efficiency ratio remained strong in the low 50s, and our allowance for credit losses is still 1.67% despite the meaningful charge-offs due to customer fraud that we will discuss later in the call.Year-to-date, we've earned $179.9 million or $3.03 per share, and we remain committed to our guidance of mid- to high single-digit loan growth and top quartile performance metrics. Now Mike Stewart will provide more insight on loans and deposits.
Yes. Thank you, Mark, and good morning to everybody. Our business strategy that's outlined on Slide 6 remains unchanged. And as a reminder that the financial results we deliver represent the durability of our business model within the primary markets of Indiana, Michigan and Ohio. We serve the diverse locations that are both in stable rural markets and in growing metro markets, and we're a commercially focused organization across all these business segments. The collective First Merchants team is actively engaged within all of our business communities and the offerings listed on this page represents the solutions we deliver.Throughout 2023, we remain committed to our business strategy, organic growth of loans and deposits and fee income, attracting, retaining and building our team, investing in technology platforms that enhance service and delivering top-tier financial metrics.If you turn to Slide 7, the map on the left side of the page offers a breakdown of the third quarter loan and deposit portfolio by state, with the right side highlighting loan and deposit by our primary business segments. The annualized total loan growth for the third quarter was on the lower end of my expectations as our commercial clients aggressively manage their working capital positions. Line of credit utilization actually reduced in the quarter and clients slowed or delayed some of their capital outlays or projects as they continue to evaluate the current interest rate environment. Year-to-date, our total loan portfolio has grown on an annualized rate of 4.6% when adjusting for the second quarter loans that we talked about last quarter. And as the earnings release stated, our loan portfolio is growing 6.4% over the last 12 months. As Mark said, mid-single-digit growth rate remains the expectations moving forward as the commercial loan pipeline ended September at the highest level we've seen in the past year. Moreover, October has already shown the benefits from the third quarter pipeline delays that have now closed.John Martin has a slide, Page 18, that highlights the year-over-year growth within the portfolio, and that slide reflects that nearly 65% of our loan growth comes from the commercial segment. And overall, our commercial represents over 75% of our total loan portfolio, with the balance coming from the Consumer segment. That segment is comprised of residential mortgage, HELOC installment and the private banking relationships. And as you can see, during the third quarter, that segment grew at a 7.3% annualized rate. Overall, the Commercial segment continues to be the loan growth engine of the bank, and we continue to get higher spreads on the new loan generation.Michele will highlight loan yields next. But within the investment real estate segment, spreads continue to widen up to 75 basis points on similar risk profile from the second half of 2022, and the C&I space spreads are widening up to 25 basis points with a strong emphasis on relationship strategies, both deposits and fees. The overall economic environment inclusive of the competitive landscape, the competitive landscape with super regional banks, in particular, firms my expectation of single-digit loan growth with improving loan yields through the balance of 2023 and in 2024 with the commercial group driving the bulk of that.Our balance sheet is positioned for that growth. Our team is positioned for that and our underwriting remains consistent and disciplined across all those segments. So if you think about the deposits that you see on that page, deposits grew 1.8% on an annualized rate during the third quarter and 2.4% year-to-date. As you heard Mark discuss from Slide 5, the commercial deposits were actually muted. The growth was actually muted by the seasonal decline of the municipal fund space seasonally paying down about $128 million. So said differently, the rest of the commercial-related deposit base grew 5% during the quarter when adjusting for those municipal fund declines.The Consumer deposit segment showed strong growth at over 9% annualized for the quarter, and this growth includes the activity through both the branch network and through our private banking team. The continued deposit growth throughout 2023, throughout the bank failures earlier this year throughout the continued Fed rate increases supports our ability to remain focused on growth.So I'm going to turn the call over to Michele and she can review more of the details of the balance sheet and the income statement drivers.
Thanks, Mike. Slide 8 covers our third quarter results. Lines 1 through 5 show the balance sheet changes for the quarter. Mike covered our loan and deposit growth in his remarks. You can see on Line 3, investments declined by $177.8 million this quarter. We sold $33.2 million of bonds during the quarter and scheduled paydowns and bond maturities accounted for another $38.2 million of the decline. The remainder of the decline was due to the change in valuation of available-for-sale securities.Pretax pre-provision earnings totaled $67.4 million this quarter, pretax pre-provision return on assets was 1.48%, and pretax pre-provision return on equity was 12.51%, all of which reflect strong profitability metrics.Slide 9 shows the year-to-date results. Loans have grown $627 million year-over-year, which was funded by the deposit growth of $212 million and proceeds from the investment portfolio sales and scheduled cash flows. Year-to-date pretax pre-provision earnings totaled $214.3 million. Pretax pre-provision return on assets was 1.58% and pretax pre-provision return on equity was 13.44% year-to-date. The tangible common equity ratio increased from 6.6% in prior year to 7.69% at September 30, reflecting that strong year-to-date earnings growth and tangible book value increased $3.17 over prior year.Details of our investment portfolio are disclosed on Slide 10. The sale of $33 million of bonds this quarter resulted in a loss of $1.7 million. Year-to-date, we have sold $347 million in bonds, creating liquidity to put to work in the loan portfolio and ensure we have a solid cash position. Expected cash flows from scheduled principal and interest payments and bond maturities for the next 15 months totals $335 million.Slide 11 shows some details on our loan portfolio. As Mark mentioned in his opening remarks, new loan yields increased 58 basis points to 7.88%. $8.1 billion of loans or 66% of our portfolio are variable rate, with 37% of the total portfolio repricing in 1 month and 53% of the total portfolio repricing in 3 months. Through the end of 2024, we have $1 billion in fixed rate loans maturing, which is 1/4 of our total fixed rate loans portfolio with a weighted average maturity of 4.64%, providing good incremental interest income given new loans are repricing at 7.88% currently.The allowance for credit losses on Slide 12 declined from 1.8% to 1.67% of total loans due to net charge-offs incurred during the quarter of $20.4 million, which John will provide details on in his remarks. We recorded $5 million of provision for credit losses on loans, which was offset by a reduction of reserves for unfunded commitments of $3 million due to a decline in unfunded commitment balances. The result was net provision expense of $2 million recognized in the income statement.Slide 13 shows details of our deposit portfolio. We continue to have a strong core deposit base with 41% of deposits yielding 5 basis points or less. Our noninterest-bearing deposits were 17.4% of total deposits at the end of the quarter, which is down slightly from 18.1% in the prior quarter. Our total cost of deposits increased 33 basis points to 2.32% this quarter, and our interest-bearing deposit cycle-to-date beta at quarter end was 51%, which was up from 47% last quarter. The big picture of what we're seeing is customer interaction and deposit pricing is lessening. So the mix shift and beta increases slowed this quarter compared to last, leading us to believe that we're getting closer to achieving deposit price stability. Although we expect the cost of deposits to continue to increase somewhat through the remainder of the year, we expect that pace will be even slower than what we experienced this quarter.On Slide 14, net interest income on a fully tax equivalent basis of $139.3 million declined $4.4 million from prior quarter. Earning asset yields increased 19 basis points this quarter as shown on Line 5 and was somewhat offset by the increase in funding costs on Line 6, reflecting stated net interest margin on Line 7 of 3.29%, a decline of 10 basis points from prior quarter. Average deposits during the quarter were $89 million higher than the period ending balance. And given we had muted loan growth this quarter, the impact put a bit of pressure on margin.Noninterest income on Slide 15 increased $1.5 million, driven primarily by a $1.9 million increase in gains on the sales of mortgage loans. We originated $192 million of mortgage loans this quarter and held roughly 30% of those for investment and sold the rest in the secondary market. Our gain on percentage, including servicing income, was 2.9%. So our mortgage team was able to contribute some meaningful fee income this quarter.Moving to Slide 16. We continue to demonstrate good expense management with total expenses for the quarter of $93.9 million, an increase of $1.3 million over last quarter. The increase was primarily due to higher marketing costs this quarter. Our efficiency ratio continues to be low, coming in at 53.91% for the quarter and 52.6% year-to-date.Slide 17 shows our capital ratios. Our strong earnings growth this quarter drove capital expansion in all ratios with the exception of the tangible common equity ratio, which declined 30 basis points, totaling 7.69% due to the impact of AOCI that I mentioned earlier in my remarks. Heading into the remainder of 2023, we feel great about the capital position, the strength in our balance sheet and are pleased with the sources of our growing liquidity coming from customers that enhance franchise value.That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John Martin, to discuss asset quality.
Thanks, Michele, and good morning. My remarks start on Slide 18. I'll highlight the loan portfolio, touch on the expanded insight slide, review asset quality and the nonperforming asset roll forward before turning the call back over to Mark.So turning to Slide 18. On line 2, commercial industrial loans originated by our Sponsor Finance Group grew in the quarter by $31 million or 15% annualized, while construction loans grew $72 million or 30% annualized. From a macro perspective, other lines of business offset this growth with total loans ending mostly unchanged in the quarter. We continue to see activity in sponsor finance lending, where we've maintained consistent underwriting and continued to see stable to marginally improving spreads. Higher interest rates are driving additional capital contribution requirements to meet our underwriting and stress criteria.Moving down to Slide 9, we slowed balance sheet growth of resi 1-4 family mortgages with $10 million added to the portfolio for the quarter. We completed the origination transition strategy in the second quarter, which is essentially stopped portfolio growth and increased sale and servicing income, which Michele just mentioned.Turning to Slide 19. We've updated the portfolio insight slide to provide additional transparency. In the commercial space, the C&I classification includes sponsor finance as well as other as well as owner-occupied CRE associated with the business. Our C&I portfolio has a 20% concentration in manufacturing. Our current line utilization remained consistent around 41%, as Stu just mentioned, with line commitments increasing $32 million. We participate in roughly $644 million of shared national credit across various industries. These are generally relationships where we have access to management and revenue opportunities beyond the credit exposure.In the sponsored finance portfolio, I've highlighted key credit portfolio metrics. There are 86 borrowers, of which fixed charge coverage of exceeds 1.5x based on the June financial data, although this has trended lower with higher borrowing cost, it remains healthy with current classified loans at 2.7% as compared to 3.8% in the prior quarter. This portfolio generally consists of single bank deals for platform companies and private equity firms, not large, widely syndicated leveraged loans. We review the individual relationships quarterly for changes in borrower condition, including leverage and cash flow coverage.Turning to Slide 20. We continue to provide the breakout of our nonowner-occupied commercial real estate portfolio with additional detail around our office exposure. Office exposure is broken out on the bottom half of the chart and represents 2.1% of total loans, unchanged from the prior quarter with the highest concentration outside of general office in medical. I've added a chart to the bottom right with office portfolio maturities, refinance risk appears low with $6.5 million or 6.4% of total office loans maturing within the next year. I also provided a couple of bullets to provide additional color into the office portfolio and its granularity with a portfolio of 219 loans and an average balance of $1.2 million. The office portfolio is well diversified by tenant type and geographic mix. We continue to periodically review our larger office borrowers and view the exposure is reasonably mitigated through a combination of loan-to-value guarantees, tenant mix and other considerations.On Slide 21, I highlight our asset quality trends and current position, NPAs and greater than 90 days past due loans decreased $17.6 million or 14 basis points on Line 5. We had 2 commercial relationships, which made up the $19 million of the $20 million of charge-offs for the quarter. I spoke to both borrowers last quarter when they were moved to nonaccrual. The first, a $14 million charge-off resulted from the previously disclosed commercial loan that was downgraded to nonperforming in the second quarter. This occurred when we received a report from the lead bank of an alleged fraud by a borrower in which we jointly participated. The syndication included 3 banks where First Merchants was not the lead an agent for the borrower had allegedly sold and pledged the bank's group's collateral out of trust. The balance was charged down based on the alleged fraud and findings uncovered during the lead bank's ongoing investigation and subsequent bankruptcy filings by our borrower and its agent. We continue to monitor the bankruptcy process and pursue opportunities for recovery.The second $5.3 million charge-off was driven by a pullback in industrial construction as a segment of the market in which the borrower focused and inability to adjust expenses.Moving down to slides or moving down to Slide 7. Classified loans declined 1.89% of loans, resulting from both the charge-offs as well as an improvement in asset quality.Moving on to Slide 22, where I've again rolled forward the migration of nonperforming loans, charge-offs, ORE and 90 days past due. For the quarter, we added nonaccrual loans on line 2 of $7.5 million, a reduction from payoffs or charges and accrual -- changes in accrual status of $2.5 million on Line 3 and a reduction from gross charge-offs of $20.9 million. Then dropping down to Line 11, 90 days past due decreased $300,000, which resulted in NPAs and 90 days past due, ending at $17.6 million for the quarter.So just to summarize, asset quality remains good. When I exclude the impact of the third quarter borrower with alleged fraud, net charge-offs would have been an annualized 22 basis points of total average loans for the quarter. And when looking at year-to-date net charge-offs, it would have been an annualized 10 basis points. Both criticized and classified loans remain in check and delinquency remains stable. All in all, we're ending the quarter with good asset quality metrics.I appreciate your attention, and I'll turn the call over to Mark Hardwick.
Great. Thanks, John. Slides 23 and 24, they just highlight some of our 10-year combined annual growth rates and returns. And then Slide 25 is the reminder of our vision, mission and our team statement along with some strategic imperatives. But at this point, I'd love to get into the Q&A portion of the call.
[Operator Instructions] Our first question comes from the line of Terry McEvoy of Stephens.
Maybe start with a question for Michele maybe. Could you just maybe talk about the repricing of certain assets as well as just ongoing increases in funding costs? And what does that mean to your thoughts for the near-term margin and when and where it might bottom?
Terry, our September -- so our quarterly margin was 3.29%. Our September margin was 3.25%. So we do think we'll see a bit more margin compression in Q4. And we are still working through our planning for 2024, although I would expect either Q4 or Q1 of 2024 to really see our margin trough. And then with the repricing of the assets that we expect to see through the remainder of '24, we should be able to see a little pickup in margin. But we'll finish our planning, and we'll be able to provide a little bit better guidance to you, I think, next quarter.
And maybe as a follow-up question for John. First off, thanks for all the details into the loan portfolio. But my question is how the underlying credit trends within the Shared National Credit portfolio, how do those differ at all from the rest of the C&I portfolio, just given there's been a fair amount of concerns with SNC loans? And are you seeing anything differentBetween your kind of core C&I business?
Yes. I'm really not the shared national credit portfolio, we're underwriting it kind of the same standard. We're not kind of -- we are running it -- underwriting it to the same standard. And really, the difference is the size of the credit itself. So frankly, there hasn't been a material difference between the 2 portfolios. If anything, it's probably performing maybe marginally better than the rest of the portfolio.
I think the portfolio, we're also seeing some of the expansion in the margin -- expansion in the loan yields.
Understood. And I guess one small one, the auto suppliers or auto parts manufacturers, it was on one of the slides, just given the prolonged strike or potential of a prolonged strike, what's the size of that portfolio? Were there any other write-downs? And do you have any other observations there?
Yes. It's interesting, Terry. When I started researching for the quarter, I tried to get to the automotive portfolio. And when I think about manufacturing, there's so much in the Midwest that's tied to auto and somehow otherwise related to it. But it's some fraction of that manufacturing total. It's harder to pull out what is directly tier, if you will, because we're not really doing Tier 1 suppliers to the automotive industry. But it's some I'll say, significant. I will say that to date, most of the changes that -- or the adjustments that manufacturers have made have been relatively minor. Production still occurs at most of the plants, and we haven't seen any direct widespread impact from either the slowdowns or some of the plant shutdowns that have occurred.Yes. I would say though that if it does -- if it were months, months of it, it will obviously have some impact. But right now, it's been kind of isolated.
Our next question comes from the line of Damon DelMonte of KBW.
Just wanted to start with Michele on a question on expenses. If you could just give us a little perspective on kind of your thoughts here in the fourth quarter and more so as we go through 2024 as far as kind of a quarterly outlook for the overall expense base.
Damon, for Q4, I would say the expense run rate will be probably be in the $94 million to $95 million range, which is really consistent with the guidance that we've provided last quarter. For 2024, we're still working through our planning, as I mentioned, to Terry. And so we'll be able to give you a better run rate probably next quarter to what we'll see in 2024.
Got it. Okay. And then on the fee income side of things, obviously, a little bit more in the mortgage banking, I think this quarter, probably some seasonality here in the fourth quarter. But do you think kind of a, let's call it, $28.5 million to $29.5 million range is reasonable as we close out the year?
I think that our run rate, what we had in Q3 would be a good run rate to use for Q4.
And then I guess lastly, on the tax rate. Do you have an estimated effective tax rate we should consider?
Yes. I think we're expecting it to be 15% to 15.5%.
Our next question comes from the line of Nathan Race of Piper Sandler.
Just going back to the margin outlook over the next few quarters. Curious to kind of hear some thoughts on some of the dynamics on the right on the balance sheet. It was great to see the borrowings held flat versus the last quarter. So just curious how you guys are thinking about kind of core deposit growth going forward and how you are thinking about funding loan growth. It sounds like mid-to digit loan growth should be restored going forward. So I imagine it's just a combination of securities portfolio cash flow that Michel alluded to earlier and then also with some incremental deposit growth. Is that the right way to think about it?
Yes, I think we're pretty confident in our ability to continue to grow our deposit base to fund our loan growth. And so that mid- to higher single-digit growth rate of loans for next year funded primarily out of deposits is what we're focused on.
Okay. Great. And then just kind of theoretically higher for longer rate environment. Do you guys have any visibility in terms of kind of how you think about where maybe bottoms and just maybe an overall growth rate for next year. It looks like you're on pace to grow in 4% to 5% this year. So any thoughts on just how NII trajects into next year under that environment?
Well, I think in Q4, with the margin compression that we think we might see at least a bit of it that we think we'll see -- there could still be some pressure on net interest income. I think once we hit that trough, though, and we make a turning point, then we should be able to see some growth. And I think the loan growth that we'll expect to see over the coming quarters will also help offset any rising deposit costs that are left until we see some real deposit pricing stability.
Okay. Great. Makes sense. And then maybe just lastly on capital. You guys are still operating with pretty flexible excess capital levels. So just curious to hear any thoughts on perhaps reengaging buybacks? Or is the plan kind of just to build capital, just given the uncertainty out there?
Yes, I'd love to be more active in the market with buybacks. We haven't felt like we spend the right time to do that. And what we'd like to just see is stability at our tangible common equity level above 8% and some certainty around the marketplace that will have less volatility.
Got it. So it still sounds like maybe M&A is kind of off the table at least through the first half of 2024. Is that a fair way to characterize kind of the prospects there?
Yes. At this point in time, we are 100% focused on internal projects. We're really excited about getting Q2 deployed our online and mobile platform for all of our customers, consumer and commercial and also getting our SS&C project completed, which is a complete replacement of our private wealth platform. So that's the priority at this point. And the trading multiples really don't lend to M&A activity. And so we're continuing to keep our relationships strong with banks that were impressed by that may be potential candidates in the future, but I don't really feel like we have the pricing power to be active at this point, nor are we ready internally to focus on M&A?
Our next question comes from the line of Daniel Tamayo of Raymond James.Our next question comes from the line of Brian Martin of Janney.
Mark, just maybe one question, Michele, on the margin. Just the spot margin for the month of September. How did it trend kind of throughout the quarter? Just trying to get a feel for that based on kind of the slowing deposit costs here.
I think it trended down pretty ratably actually. And so it ended up landing at $3.25 at the end of September.
Okay. Okay. And the -- and I guess your commentary with the deposit costs flowing and kind of the -- what you outlined as far as the fixed rate loans at reprice, your expectation is that the loan yields continue to expand here in the next 3 to 4 quarters, just given that repricing that's occurring? Is it along with -- I mean that's kind of the message with the kind of the stabilization you're seeing in the funding side.
Yes, this is Mike Stewart. I do think that -- seeing it on the commercial side, the mortgage that we put on would be the same way. So yes, on the repricing and any -- I think we're doing in the HELOC, all that should drive higher loan yields.
Okay. And as far as when that may trough, I mean, if the deposit costs are close to troughing, I mean we're at least 3 to 4 quarters out as far as that remix or the benefit coming through on that -- on those loan yields given what you're seeing today?
Yes. I mean our model show if rates stay steady where they are, that we'll continue to see increases through all of 2024.
Yes. Okay. Perfect. And then I appreciate all the color on credit. Just as far as kind of the reserves and actually kind of recording a provision this quarter, just kind of how to think about that in the context of where credits at. Obviously, we're pretty good outside of the one fraud situation this quarter. But just any thought on how we should think about modeling that you're projecting going forward given the credit environment?
Yes. I think from a provision expense perspective, it's going to be a replacement kind of a trading dollars on a replacement side, meaning that we'll provide for charge-offs with potentially some release in the ACL. As far as charge-offs go, I think we've given guidance in the past of those being between 10 and 20 basis points a quarter.
Okay. And just your thoughts, John, on the -- as far as credit goes, kind of you talked about the SNC being pretty good, are maybe better than the other portfolio. But just within the traditional portfolio, where are the concerns to? I mean, we've seen a handful of other banks have some issues this quarter and just kind of ongoing. But if you look to your portfolio as far as where the greater, I guess, what you're may be more mindful of today paying more attention to. Can you give us any thoughts there?
Yes. Brian, when I think about potential impacts from higher rates, I think about it in the construction portfolio just because what you underwrote to and the appraisals that you had potentially upfront are going to necessarily drive tighter cash flow coverage. When I think about the broader portfolio, across the spectrum within the commercial loan portfolio, we underwrite, we stress, we do multi-variable tests upfront on our C&I borrowers. And so there's not one particular portfolio that I'm looking at, that concerns me maybe more than another. But even in the construction portfolio and as we add new names, those are requiring additional capital as our -- as I mentioned, in that portion of my speech, Brian, around the sponsor finance portfolio, the things we're underwriting today, I feel pretty good about because they have the higher interest rates already built into them. So I don't know if that answers your question. I wish I could say it was this portfolio or that portfolio. But generally speaking, to this point, absent the -- and I'm not going to use the word idiosyncratic, the fraud event that occurred, maybe construction, but that would be it.
Okay. And getting the renewals today on some of these credits, the commercial real estate credits, has that been a problem given the increase in rates that are coming to these folks? Or I guess, has that been those loans really are getting renewed without an issue at this point today.
Well, what happens, Brian, at some level, is that when you have a construction project, you've got a conversion covenant requirement that they need to meet in order for them to move to the secondary market. And with higher short-term rates, the way we measure it on short-term rates, it's tighter. And so we're requiring a maturity, a number of different strategies, but one is potentially additional capital being put in, maybe marginal rightsizing, maybe additional guarantees, additional collateral. But from a extend and pretend as the industry might colleagues like to say, it's more just a strategy around what to do when interest rates maybe are challenging on a particular project.
I don't think it's safe to say -- I'd just jump in. I'd say most of those loans aren't going through a renewal process. They're putting in the secondary market. Those are strategies we employ if we needed to, but if we -- we're not necessarily seeing any of that, right? Right.
And on the renewal specific, if I'm understanding your question, something that might have had a renewal after 3 or 5 years, borrowers have had the opportunity to increase rental rates and change the dynamics of an individual project or an individual property. So we haven't seen issues necessarily related to borrowers inability to get renewed as a result of the higher interest rates.
Yes. No, I appreciate it. I was really talking about the commercial real estate not construction, but I appreciate all the comments on it and just trying to understand that.
Valerie, I assume, does that conclude the Q&A portion? Mr. Tamayo had a question, but his line may be muted. Okay. So that does conclude our Q&A portion. I'd like to turn the call back over to Mr. Hardwick for any closing remarks. Great. Thanks, Valerie. I hope you can hear the confidence that we have in our business model. Our margins are healthy. Our capital is strong. Our efficiency is in top quartile kind of performance range. And more importantly, we're confident that we will continue to achieve our growth rates for both loans and deposits into the future. And if we do that, we're taking care of the needs of the community that we serve and likely taking care of all of our stakeholders. So we appreciate your time today. We appreciate your investment and interest in First Merchants. Look forward to talking to you soon.
Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating, and have a great day. You may all disconnect.