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 Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions]
We will be using user-control slides for our webcast today. Slides may be viewed by following the URL instructions noted in the First Merchants' news release dated Thursday, January 25, 2018, or by visiting the First Merchants Corporation shareholder relations website and clicking on the webcast URL hyperlink.
The corporation may make forward-looking statements about its relative business outlook. These forward-looking statements and all other statements made during this meeting that do not concern historical facts are subject to risks and uncertainties that may materially affect actual results. Specific forward-looking statements include, but are not limited to, any indications regarding the financial services industry, the economy and future growth of the balance sheet or income statement. Please refer to our press releases, Form 10-Qs and 10-Ks concerning factors that could cause actual results to differ materially from any forward-looking statements.
Please note, this conference is being recorded.
I would now like to turn the conference over to Mr. Michael C. Rechin, President and CEO. Please go ahead.
Thank you, Austin. Welcome to our earnings conference call and webcast for the fourth quarter and full year 2017. Joining me today are Mark Hardwick, our Chief Operating Officer; and John Martin, our Chief Credit Officer.
First Merchants released our earnings and our press release approximately 10:00 Eastern time today, and our presentation speaks to the material from the release. The directions that point to the webcast are also contained at the back of the release, and my comments begin on Page 3, a slide titled Fourth Quarter 2017 Financial Highlights.
So we announced earnings for the quarter of $24.4 million in net income, a 9.4% increase over the fourth quarter of 2016. The raw earnings produced earnings per share of $0.49 and include the combination of $6.5 million from deferred tax asset write-down and acquisition expenses, which total, between the 2, $0.12 per share. Mark will speak to that momentarily on a more separated basis for full understanding.
Otherwise, in the quarter, very strong net interest income, which benefited both from strong volumes and margin. The net interest margin expanded to 4.1% following the December rate move. Otherwise, we completed the conversion of IAB, really excited about that, middle of the way through the fourth quarter, the weekend of November 12.
And going back to the net interest income, really strong volumes that we're earning in the marketplaces. Organic loan growth of $270 million, a 16.7% annualized growth rate. John will talk about what was our highest volume quarter of the year and comment on that later in his remarks. And then organic deposit growth of -- in the quarter of $262 million, a 15.1% annualized growth rate as we continue to have a really active focus on deposit gathering in all of our lines of business.
Flipping to Page 4 where you look at similar metrics, but over a full year basis. Record net income of $96.1 million, an 18.5% increase over full year 2016. Earnings per share of $2.12, a 7.1% increase over full year 2016, the highest in this company's history. Those results include $17.3 million combination or $0.29 per share of acquisition expenses and DTA write-down that straddle, obviously, both the fourth quarter and the full year. And again, Mark will provide some detail here momentarily.
Total assets for the company grew to $9.4 billion, nearly 30% over 2016, a really pleasing combination of organic growth and some footprint growth through the 2 acquisitions.
Full year organic growth on the loan side, $658 million, reflecting a 12.8% growth rate, really taking advantage of a vibrant Midwestern marketplace and productive specialty niches that continue to grow. Again, John will speak to those, in particular, later on.
Tangible book value increased to $16.96 per share, 7% gain over year-end 2016. We grew our franchise. I think 2 really well-directed investments into 2 attractive marketplaces through the acquisition of the Arlington Bank in the Columbus Market and Independent Alliance Bank as our entry point into the Fort Wayne market. Just slightly different attributes. Columbus is our third acquisition there coupled with organic growing of the bank that's nearly 15 years old at this point, so we have a pretty good handle on the growth opportunity in that market. And Fort Wayne, which we talked about in the second half of the year, as a new market to us, although the First Merchants -- legacy First Merchants franchise got us up into the Wabash indicator markets, really close by, so we're happy to be able to get into the core of that attractive market.
Lastly, and really most recently, a January release from a third party, Forbes Magazine, recognizing the bank First Merchants as a top 5 ranking in America's Best Banks using several criteria that kind of balance -- include a balance sheet, income statement, capital levels, asset quality and efficiency. So very, very exciting for our whole team to cap a year of hard work and seeing the results of that work.
So at this point, I'm going to turn the call over to Mark to go deeper into the financials.
Thank you, Mike. My comments will begin on Slide 6. Total assets on line 8 increased in 2017 by $2,155,000,000 or 30%. As Mike mentioned, the increase was the result of both organic growth and acquisition activity.
On line 3, strong organic loan growth of $661 million or 12.8% is even stronger than 2016, 9.5%; and 2015's 9% organic rate.
M&A growth resulting from our Arlington acquisition in May and our Independent Alliance acquisition in July accounted for $950 million or 18.5% of our growth, a combined 31.3% growth in our loan portfolio.
Additionally, the investment portfolio on line 1 increased by $256 million. Most of the growth was due to M&A activity and additional liquidity that we were able to put to work as well as opportunities in the municipal bond portfolio related to refunding opportunities late in the fourth quarter.
The allowance on line 4 in total dollars increased $9 million to $75 million in '17 due to loan growth in the portfolio and a decline in loans covered by a fair value M&A loan marks.
The composition of our $6.8 billion loan portfolio on Slide 7 continues to be reflective of the commercial bank and it continues to produce strong loan yields. The portfolio yield for 2017 totaled 4.76% compared to 4.58 in 2016 and 4.42% in 2015. This 18 basis points improvement over 2016 and 34 basis point improvement over 2015 was expected given the meaningful increases in the Fed funds rate in our assets since their balance sheet. The impact of fair value accounting for 2017 is just under 20 basis points, which is about 1 basis point less than the impact 1 year ago. So just pointing that out, given that -- to highlight that the growth in our yields in the portfolio were really core and not fair value-driven.
On Slide 8, our now $1.6 billion bond portfolio continues to be high performing. Our 3.90% yield is 12 basis points better than last year and is slightly better than our current investment rates. Given the rising short-term interest rate environment, it's unique that long-term rates have declined resulting in an unrealized gain position of $23 million.
Now on Slide 9. Non-maturity deposits on line 1, which represent 80% of total deposits in 2017 totaled $1,313,000,000 -- or, I should say, grew $1,313,000,000 or 30%. Of the growth on line 1, organic growth totaled $425 million or 10% and acquired growth totaled $888 million or 20%. Customer time deposits on line 2 increased by $304 million or 41%, organic growth totaled $77 million or 10% and acquired growth totaled $227 million or 30%.
As I previously mentioned, the mix of our deposits on Slide 10 continues to drive strong net interest margins as our 2017 cost of deposits was just 49 basis points, an increase of 11 basis points over last year's total of 38 basis points.
All regulatory capital ratios on Slide 11 are above the regulatory definitions and are well capitalized in our internal targets. We believe the strength of our 9.3% tangible common equity ratio and our 13.69% total risk-based capital ratio will continue to provide optimal capital flexibility into the future.
The corporation's net interest income on a fully taxable equivalent basis on Slide 12 grew by $54.5 million or 23% during 2017, totaling $294.5 million. And net interest margin increased 13 basis points for the year, totaling 4.02% compared to 3.89% in 2016.
In 2018, net interest margin on a fully equivalent basis will reflect the impact of reduced tax rates, causing approximately 12 basis point -- a 12 basis point decline in reported margins. But obviously, the bank will be significantly more profitable as a result of tax reform as net interest margins and efficiency ratios are negatively impacted and ratios like EPS, ROA and ROE improve significantly. We can discuss those in more detail during the Q&A session if you're interested.
Total noninterest income on Slide 13 improved by $5.8 million during the year. The growth was driven primarily by acquisition activity, coupled with good organic wealth management activity.
Noninterest expense on Slide 14 totaled $205.6 million for the year, up from the prior year total of $177.3 million, given the addition of $950 million in acquired loans and $1.1 billion in deposits, increases are expected.
When adjusted for M&A expense of $12.2 million and new market operating expenses of $10.5 million to $11 million, core expenses grew by approximately 3% in 2017.
I know the next couple of items are small, but I wanted to highlight that in our salary and benefit totals on line 1, we had fourth quarter settlement accounting charges related to our pension plan. We offered a lump sum distribution opportunity to participants this year. And we had approximately $3.9 million paid out of our frozen plan. The payments required us to record a $761,000 charge through income reclassified out of accumulated other comprehensive income in the equity section.
Additionally, as announced on January 15, a reward for the company's strong 2017 performance was paid to -- or was announced to all associates, excluding senior management, that they'll receive a $500 onetime cash bonus, which was accrued in the fourth quarter of 2017. So that totaled $750,000 and it is in the '17 results. Both the pension supplement accounting charge and the bonuses are reflected in those results on Page 14 in line item 1.
Now on Slide 15. Net income totaled $96.1 million and EPS grew by $0.14 per share or 7.1% to $2.12 a share. As highlighted previously, the impact of the tax cut and JOBS Act totaled a charge to our deferred tax asset of $5.1 million, and its additional expense is highlighted -- or it shows up in line 7. And as previously mentioned, our M&A onetime expenditures and our settlement accounting charges totaled $12.9 million, and they are in line 5.
Despite all these charges, EPS on line 9 is still up 7.1%. And when adjusted for the $0.30 impact of all these noncore items, EPS improved by $0.44 or 22.2% for the year. You will notice that when adjusted for onetime charges -- onetime items, our trends in both efficiency ratio and earnings per share are top quartile, strong and they have an excellent trajectory.
Slide 16 is the same information in a quarterly format for your review, and Slide 17 and 18 are nice scoreboards of our results.
On Slide 18, we are pleased to have grown tangible book value per share by 7%, while paying dividends that are 4.1% of tangible book value after -- and also completing 2 meaningful acquisitions during the year. We're pleased to have delivered on our mission by being the most responsive, knowledgeable and high-performing bank for our clients, teammates and our shareholders, again, in 2017.
Thanks for your attention. And now John Martin will discuss our loan portfolio composition and related asset quality trends.
All right. Thanks, Mark, and good afternoon, everyone. Beginning on Slide 20, I'll be updating trends in the loan portfolio, review a summary and reconciliation of our asset quality, discuss provisioning fair value and allowance coverage and then end with a few comments on the portfolio.
So on Slide 20, total loans on line 11, which excludes loans held for sale, grew in the quarter, $268 million or 4.1%. For the year, loans were up roughly $1.6 billion, which included both the Arlington Bank and IAB portfolios. Excluding these portfolios, loans grew organically roughly $658 million or 12.8% year-over-year -- excuse me, over year-end 2016.
Returning to the top of the slide and then working down quarterly -- came -- excuse me, working down, quarterly growth came from increases in the commercial and industrial loan category on line 1, a $58 million; construction loans on line 2, $113 million; CRE owner-occupied loans on line 4 of $25 million; residential mortgage loans where we grew $24 million on line 7 and public finance of $65 million on line 7.
2 anomalous changes in the quarter to point out were the unusually large increase in construction draws in December as well as the effect on the public finance portfolio from the change in the tax code.
With respect to the construction portfolio, specifically, the dynamics are driven, as I've mentioned in prior calls, by project funding during the construction phase, while moving to either the permanent market or into the bank's loan portfolio at project completion. During the quarter, we saw construction commitments pretty much level out and grew a little bit. But -- while there was meaningful draws on the existing lines that we had are already established. I would expect to see the portfolio continue to trend positively, although not at the same pace as we saw in the fourth quarter.
And with respect to the growth in the public finance balances, I'd point out that roughly 1/3 of the $65 million increase in the quarter was tied to the change in the tax law relating to advanced re-fundings for municipalities. So all the loans, again, grew at an annualized rate above 16%. I would continue to expect a more normalized rate of growth in the mid- to high-single digits.
Then briefly, finishing out the slide on lines 12 and 13, we continue to remain below the regulatory real estate concentration guidelines of 100% of construction loans to capital and 300% of investment real estate to capital.
Turning to asset quality on Slide 21. We saw asset quality improve, both in the quarter and for the year. On line 1, nonaccrual loans declined $3.6 million for the quarter or $1.3 million for the year to $28.7 million or 4.3% of total loans, 43 basis points. This represents a decline from the 0.58% of total loans at the end of 2016 and 0.50% -- or 0.5% at the end of the third quarter.
Other real estate was lower in the quarter by $1.5 million and up roughly the same amount for the year, while total renegotiated loans and 90 days past due were up modestly in the quarter, but down for the year.
This resulted on line 6 in NPAs plus 90 days past due over loans and ORE of 0.6%, down from 0.9% at year-end and 0.7% from the last quarter.
Then finishing out the slide and moving down to line 7, classified assets declined $16.5 million in the quarter and were down $21 million for the year, despite adding classified assets from both the IAB and Arlington portfolios.
Turning to Slide 22, which reconciles the annual migration of nonperforming assets and includes the prior additions of Arlington and IAB. We started the year in the far right column titled 2017 with $43.8 million and NPAs and 90-plus delinquent. From there, we added or acquired $30.1 million of new non-accruals and gross charge-offs of $5 million on line 9 -- or excuse me, on line 5, which netted to a $1.3 million decrease in nonaccrual loans on line 6.
Dropping down to line 7. We added $8.1 million in new ORE, while on lines 8 and 9, we sold $5.6 million for writing off about $1.1 million during the quarter. So after changes and restructured in 90 days past due, we ended the year with -- we ended the year $2.8 million better than we started after adding $1.6 billion in acquired portfolios.
So turning then to Slide 23. The allowance on line 4 grew to cover increases in the non-purchased loan portfolio and at year-end stands at 1.11% of total loans and 1.36% of nonpurchased loans. The fair value adjustments on line 8 decreased $4.1 million from 50.4% to 46.3% with all 40 -- $4.1 million in accretion with no offset charge-off.
So really, summarizing then on Slide 24. Strong quarterly and annual organic loan growth, as we mentioned before, led by construction, public finance and C&I. But the high end of the expected loan growth rate is reflected of construction, advanced timing, some incremental public finance advanced refunding effect and a really strong C&I activity in the quarter, the core activity in the quarter. Credit quality that is stable and improving with minimal net charge-offs and loan growth serving as the primary driver for provision. It's a good part of the cycle, and we continue to take advantage of the opportunity.
So I'll turn the call back over to you now, Mike.
Thanks, John. I'm going to move, before we take questions, to the page titled Looking Forward, that's page #26, and some summary thoughts. So -- and Mark described this. The tax reform benefits in '18 are going to manifest themselves in, obviously, a much lower effective tax rate change and I'm calling here for something about a 10 percentage basis point reduction somewhere to around a 16% level. And so the benefit of that in a press release that we covered around compensation changes or some of our other plans involving new and enhanced technologies, really excited about it. The compensation changes are intended to recognize and galvanize a really talented team that we have at First Merchants. The branding investment is going to be spent to speak to our current and future clients. And we feel like there's still some optimization in all of our work areas around where technology can help. All 3 of those areas intended to drive greater shareholder value.
Next bullet point talks about -- to the acquisitions. The -- we know that there's some synergies to be gained. We're past the conversion activities of the third and fourth quarter owning to the 2 acquisitions. And yet, we're still keenly focused on the cultural integration of all the bankers that have joined our company knowing that they're still adjusting to the new company that they are a vital part of.
Arlington's case, really super, adds to 2 prior acquisitions makes us even more of a full-service Columbus bank, able to compete at a high level. And Independent Alliance Bank, really exciting. As a matter of fact, today, well, while we speak, there's another press conference taking place by Will Thatcher and Mike Stewart talking about sizable investments we're making there in terms of a brand-new headquarters in downtown Fort Wayne, really consistent with what the business leaders and the mayor of Fort Wayne are hoping to do in a downtown that grows quite quick and to take all of the IAB assets, which had typically been historically around the periphery of the Manor market and move to a new market headquarters for First Merchants in that market.
Talk about expanding some of our businesses. John talked about the growth that we've seen in the municipal business and sponsor business. We're going to continue to expand them and that means more resources and more focus. In an asset-based lending business, that's quite small at this point given the point in the cycle, but a sponsor business, public finance and then more resources for loan syndication to try and take fullest advantage of the origination opportunities that we see.
Mark covered the net interest margin trends, which, I think, demonstrate the asset-sensitive commercial banking balance sheet that we've talked about for years. I feel like 2018 offers the opportunity to take full impact of the fourth quarter increase and any subsequent increases that could take place. We're trying to keep a close eye on what that means to our deposit cost of funds knowing that while subsequent changes might be shared more broadly on each sides of the balance sheet, they would still be net positive to us.
Next bullet point was from the last quarter as well. Put a lot of work into listening to what our customers say, what their preferences are as to how they use the bank. And so we're rolling out, right now, new product designs in some of the most traditional checking products, but specifically featured to the way that people like to use the bank. And so we're excited about that.
And we haven't lost sight of the fact that a $9.4 billion changes ahead, whether we grow through that threshold organically or through continued acquisitions, we have a very good hand on the preparedness for that and had been putting people resources and dollar resources into the point at which that becomes a front-burner item for us. But it's getting a lot of attention all throughout 2016 and 2017.
So in summary, I appreciated Mark's clarifying comments around fourth quarter results, in particular. There's a lot going on in there. All of it quite good and yet, it needed some of the detail to fully understand what the core earnings engine is in the company. And I feel like, overall, our team took full advantage of a really attractive banking environment. John talked about the cyclicality of the business and trying to take full advantage of where we are. I feel like we did a nice job in posting really strong results. The execution, I'm very proud of. We look forward to 2018. It appears to be a very similar environment. Most of the macro level items, pretty similar. And then you put the tax reform impacts on top of it. And if we invest those prudently, it ought to drive our results even higher.
We know we are in attractive marketplaces. You might have noticed that Columbus and Indianapolis that we've talked about for years in this thing are 2 of the markets that are Amazon client list. So there's people other than First Merchants executives that feel like we're well situated in all of the other markets we're in, benefiting from those same, really, stabilizing elements and growth attributes.
What we're most focused on are things we can control. We feel good about our 2018 plan.
So at this point, Austin, I'm going to turn the call over to questions that you might have in the queue.
[Operator Instructions] And our first question comes from Scott Siefers with Sandler O'Neill.
Mark, so I appreciate your calling out those couple unusual items in the expense base and clarifying that. So looks like if we net out all the noise, you're starting from a fourth quarter kind of core expense base of $53.5 million. I think when we talked last on the third quarter conference call, you guys had suggested we'd see a bump-up in expenses in the fourth quarter and then maybe comes down -- back down to kind of like the $51 million per quarter range thereafter. Is that still something you guys are thinking? Or has there been any change in your thinking on investment spending with the tax provision, et cetera?
As we work through all the financial planning aspects and including some of the raises that we talked about for our nonexempt stuff, we're really are budgeted -- we're coming in more between those 2 numbers. We've talked about 50 -- $53 million and $51 million. And we're kind of anticipating, as we go through the year, that's it's going to be more like $52 million to $53 million per quarter on a go-forward basis.
All right. Perfect. And then, let's see. I think you said about 12 basis points hit to the fully taxable equivalent margin due to the lower tax rate. Wondering if you could provide sort of that same adjustment on the tax rate. So let's see, 16% effective tax rate. What would that imply for fully taxable equivalent tax rate going forward? Is something in the -- like the 21% range fair?
No, the fully -- well, the effective tax rate is going to move down to about 16 %. So I'm not sure if I'm answering the right question. And on the margin, it's 12 basis point reduction because the taxable -- tax-exempt items will gross up as much.
Right. So all else equal, I guess, we'd be talking about -- if you did a 4.10% margin in the fourth quarter, that'd be -- the new run rate would be sort of a starting point of like 3.98%. Is that right?
That's correct, yes.
And -- yes. And then on the tax rate, so you've got the lower effective tax rate, but on a fully taxable equivalent basis. I think you guys have been running in kind of, like, the, I don't know, 33%, 34% range, reasonably fully taxable equivalent. So just trying to get a sense if, like, low 20s is the appropriate number to use for an apples-to-apples. In other words, if we make the adjustment to the margin, same thing for the tax rate as well.
I may -- I'll have to get back to you on that and -- because I'm not -- we're not all following exactly the calc you're talking about.
Right, yes. We can check kind of one offline.
Yes. The -- or I can share some of our recurrent asset improvements are about 18 basis points. And on a return on tangible common equity, it improves the return on equity about 2 full points. Just for -- but that may be what you're trying to get -- add is to have -- to get the same kind of impact along the -- in ROAs and ROEs.
The next question is from Nathan Race with Piper Jaffray.
Just in terms of loan pricing in the quarter, it looks like the core loan yields were up a few basis points sequentially. So obviously, I would imagine that's partially driven from some of the construction runnings that you had in the quarter. So just curious how spread they're trending and just any other commentary on just some of the competitive dynamics that you guys are seeing.
Yes. Before we get into the competitive dynamics, just the fact that we have an asset-sensitive balance sheet and we continue to see rate increases in both Fed funds and LIBOR. We're experiencing nice net interest -- I'm sorry, interest income expansion and yield on earning asset expansion quarter-over-quarter. So I think that's the first item that I would cover and then I'll let Mike talk about the competitive aspect.
Yes. In terms of the competitive aspects as it relates to driving pricing, I would offer that middle market C&I. I think, really hasn't changed much. If you think about John's comments about where this increased volume came from, the municipal lending side of that would be on the lower end of a normalized yield, whereas construction draws to your point and sponsor financial beyond the higher end. If you think about those aspects of how it moves the norm, but the actual competitive environment hasn't changed much. The mix has a little bit of a drive in that. And I think you're right. Construction project have more risk and, as such, they are typically floating rate benefit from the rate increases and including fees that ultimately get amortized into the yield.
And the only thing, Nathan, I would add is that the more of the higher end of the middle market and as much as we see those transactions, that's where the pressure comes in, where the super regionals are bidding down, call it, a multinational opportunity or shared national credit. And the middle market kind of core in our community and the sponsor deals, that's been pretty consistent over the last several l quarters and years, actually.
Great. That makes sense. I appreciate that color. And just kind of thinking about deposit cost increases, we obviously saw some pretty pickup in the fourth quarter here. So just curious, I guess, anything about deposit pricing assuming we may be getting 2 rate hikes in 2018?
It's really very similar to what John just said. It's our largest deposit categories. The way we're seeing pressure to move rates. And I think if you average out all of the rate increases that we have seen this year, it remains just kind of a daily average and then look at the increase in our deposit. It's about 20%. And so when you look at beta, that's kind of where we're running today. And we think that we'll continue to just see pressure on the largest categories as rates continue to rise. So...
Our next question comes from Damon DelMonte with KBW.
So my first question is just kind of as it relates to the margin. Mark, thanks for the color on the impact to the FTE adjustment and the new tax rate. How are you guys positioned currently with additional rate hikes in 2018? Have you -- is your asset sensitivity changed at all or still the same?
That's a good question. We've integrated the -- our 2 acquisitions this year. And we have all of the combined data coming out of core systems. So it's always nice to prove out your -- our expectations. And we still have a very asset-sensitive balance sheet. We have $3 billion and almost $400 million of, like, daily repriceable loans and investments, primarily loans and primarily driven by LIBOR and prime. But that allows us to really benefit as rates continue to rise. We've really modeled our margin a couple of different ways with the continued rate hikes. And if the December 1 was the last one, what did we expect? Because we would -- eventually, when rates stop rising, you start to have the deposit side catch up. And we're convinced that we have low-cost deposits that perform really well in a rising rate environment, very asset-sensitive assets that perform in a rising rate environment. And when the rates increases stop, we think we have the ability to increase deposits over time in a level where we control earnings throughout that period. So we still feel very good about it, even though we've added 30% to our balance sheet.
And as we look at the margin, so this quarter was, I think, what, 3.90% was the -- I'm sorry, 4.10% was the reported margin this quarter. When you take into account the impact from the FTE adjustment and then the rate hike in December, are we just done a little bit, you think, from this quarter on a net basis?
Not now. We feel really good about the level we reported because the last rate hike happened so late in the quarter that we will have the benefit of it through all of the first quarter of this year. So we really just think it's more about adjusting the margin expectations for the 12 basis points that we'll lose in the calculation based on a lower tax rate.
Got you. Okay. That's helpful. And then with regard to the loan growth, can you just provide a little bit more color on some of the construction projects that were drawn down on and also where your current pipeline stands or unfunded commitment?
Sure. We have about between $1.2 billion and $1.3 billion in construction commitments, so about 50% drawn into the total project. The portfolio, as I think I might have mentioned on previous calls, sits multi-family at about half of the total with senior being 1/4 and student being another, call it, 10%. Those are probably the biggest categories within the construction portfolio that we have with the draws occurring really, obviously, in the multi-family and the -- that portion of the portfolio. I don't have a breakdown as to what percentage drew from each of those categories, though.
Okay. And what's like -- what's the typical size of these loans?
Our whole position versus the aggregate, they can be $25 million to, I'll say, $15 million to as high as $30 something million, and we'll take a percentage of the total. We typically don't hold the full amount, unless it make sense.
Got you. Okay. And then, I guess, just lastly, at $9.4 billion in assets, if you were to grow the balance sheet roughly 7%, which is not unrealistic organically this year, you would -- you'd cross -- effectively crossover $10 billion in assets. Mike, can you just give a little perspective on your thought as if a deal comes along, it's probably something you would jump on to comfortably get you over $10 billion, but If the right deal doesn't happen and you're organically getting close to that $10 billion, would you guys kind of manage the balance sheet, such that you could get another year out of crossing over $10 billion?
Yes, I think we would. We're going to try and arm ourselves with some flexibility and that would clearly be absent any M&A. The ability to still take great care of our clients, operate all of our lines of business and yet try and manage the timing of that. But yes, to get through 2019 -- I'm sorry, '18 absent M&A and yet still take care of our clients, I think that would probably be one of the strategies.
The next question comes from Erik Zwick with Stephens Inc.
Starting on loan growth, and I apologize if I missed this in the remarks, what is your expectation for annual loan growth in 2018? And then maybe kind of the second part of the question, which of your kind of key markets with -- in the Fort Wayne Columbus present the greatest opportunities this year?
Well, the -- except John, I would think all of us were pleased and yet mildly surprised that the strength of the loan growth in the fourth quarter was the highest of the 4. And prior calls of this nature, right up through the third quarter of 2017, would have had us talking about a 6% to 8% expectation. And obviously, we were a heck of a lot higher than that in the fourth quarter and somewhat higher than that in the third quarter. And so as I think about 2018, and based on the local economies continuing to do well, I think that to be at the higher end of single digit in the 8% and 9% annualized growth rate feels about right to us. The fourth quarter, as I mentioned, I thought was somewhat of a positive aberration. And John talked about a couple other reasons why the change in the tax law had some of our public finance business accelerate some of their activity. And then the construction draws as John was just speaking to, we're at the higher end of activity there as well. Somewhat of a mild winter fourth quarter, it just allowed for a more active fourth quarter construction season that typically tapers down a little bit from the third quarter. We didn't see that. And as you talked about, we're at about 50% utilization of our aggregate construction line. So still feel very, very good about it. But 8% to 9% is kind of what we're looking at based on the plan we've drawn up.
Okay. And thoughts on just -- maybe kind of give me the outlook for how the growth will be sourced geographically between your key markets.
Yes, yes, yes. I apologize, I missed the back half of your question. So I think Central Indiana and Central Ohio are going to drive that. We really look forward to seeing a full year what our Fort Wayne entry can do for us, so we're excited about that. I do know that based on the strength of the fourth quarter, when I -- if you see, why would I back down to the 8% and 9%, our pipelines are down modestly based on the strength of the fourth quarter. And yet, a category that we track for opportunities, which have not yet been committed to, remains really at a pretty high level. But our raw committed term sheet out in documentation pipelines are a little bit lower across mortgage and commercial.
That's great color. Maybe switching gears to M&A. What is your read on kind of bid and ask spreads today? And which markets are you seeing potential opportunities? And how are you feeling about potentially getting another deal on the books in 2018?
I think our approach to it has really been consistent, about looking around our core franchise and maybe the periphery of our core franchise and the markets we go into with a high level of confidence, both about leadership that we could either have or attract and marketplaces and customer behaviors feel like the rest of the company. And so I think there's going to be several of those opportunities. The added variable for us, and it has been this way for the -- certainly all of 2017 is to try to do something that's not only smart from a pricing and execution risk standpoint, but keeping that $10 billion level in mind to make sure we understand the ramifications. The bid-ask spread, I think the people that run good companies would expect to be paid really full price for it. We would expect to pay one assuming that their synergies that correlate to those as well. So our perspective on it really hasn't changed.
And one last one, if I could, on credit. You've had 3 very strong years with the net charge-offs of 5 basis points or less even. As you look into 2018, is there anything in your -- as you kind of comb your credit and look at your loan portfolio, that gives you any concern that we would see a material increase from this standpoint? And maybe thoughts on -- does the tax reform potentially extend this current kind of cycle even further?
Yes, that's a good question. I've looked at the tax reform is giving the economy a kind of a shot in the arm and continue to propel our customers, our borrowers. And I do see that as kind of extending the period of performance, if you will, before there's any possibility -- before the possibility of recession hits. And while it's hard to predict the future as it relates to the economy, there are a lot of things that are -- a tailwind, if you will, when I look at what's happening. As it relates to the construction portfolio, we're -- we do have multi-family in there. We do have seen -- we do have construction that -- just the nature of which is will the level of rent, the lease-up, et cetera. And to this point in the cycle, we've been pleased with the performance in the portfolio in the way it has stabilized. So there's nothing that I see at this point that in that portfolio gives me concern. C&I borrowers are -- continue to perform with the individual situations that -- and naturally occur in a loan portfolio. But on balance, winds at our backs, so that the economy is back, the tax cut is going to help. And I see the -- just a watchful eye on the portfolio as we go forward.
Our next question is from Brian Martin with FIG Partners.
So most of my stuff has been answered. Just a couple little things for me. Mark, just on the accretion number, yes, I guess, can you just give us any thoughts on kind of big picture on '18, how you're thinking about that? It was a little bit higher this quarter but just, in general, how to put a fence around that or a range on how you're thinking about the accretion number.
Yes. We're -- what our year was $12.6 million, and we're really budgeting and expecting a very similar number. I mean, I think it's around -- right at $12 million. And that's just using the models and having some expectation of pay downs that would accelerate some of the accretion, we get to about a $12 million number. So...
Okay. And pretty consistent among quarters, there's kind of a declining trend on that.
It's -- yes, a little declining. Yes, that's a good question. Because of the most recent acquisitions, it seems like they are heavier at the beginning and start to tail off where you have a little bit more just amortization running through and fewer surprises.
Yes. Okay. And then just on the core margin this quarter, I guess, if you guys kind of peg at it 3.90% level market, it sounds like it probably trends a bit higher in the first quarter given the December hike. And then, I mean, I guess, what's your thought be that if you get another rate increase or 2, there's maybe a lesser benefit, but still a benefit to the -- that core margin, so that the core margin ought to be under that outlook of rates going up that it -- the 3.90% should kind of continue to step up throughout the year, and does it level out just -- if you think if -- I don't know what's in your forecast as far as rate increases, but just maybe talk about -- if you get the bump in the first quarter, a little bit of bump from that 3.90% level on the core, how you're thinking about the balance of the year.
Yes, we, in our planning process, didn't forecast additional increases and -- which, if you look at it that way, there's a little bit of pressure on deposits, even though we're going to get a nice pickup in the first quarter from the December rate move. That would just say, as if more rate hikes happen, the real question will be what happens to the long end of the curve. So as -- this year, the long end came down when the short end came up, and that's not really optimal. And so if we get more and all it does is flatten out the curve, then I think we can expect less benefit from it. If the curves deepens, that's obviously really beneficial to banks. So...
Okay. In your comment about the first quarter just as it relates to what you expect if the deposit beta stay kind of where they're at, they're still a handful of basis point impact just from the asset sensitivity in the December hike. Is that kind of fair to, at least, think of a starting point for?
And maybe 2 or 3 basis points. Not a lot.
Okay, okay. And then maybe just 2 other things. Maybe one from Mike. Just on the commercial pipeline, Mike. I mean, can you just -- do you have the -- where that pipeline in dollar terms, the absolute dollars of where it was at year-end versus where it was kind of third quarter? Or I guess, the frame of reference you have before the...
Yes, I do. I can give you that. Yet some -- we ended the year at $260 million, which is down $125 million from the end of the third quarter, roughly 3 -- just less than $390 million. And yet, when I look at the components of it, kind of consistent throughout. The debt capital markets business, which would house that municipal business is down. It was in the $40 million to $50 million level all the way through the middle of 2017. That's down based on some of the December closings that we had. But offsetting that decline is a category that I referenced in a prior question, Brian, you might have heard it, about other opportunities in front of our adjudication process, which remains really high. It's the better part of $1 billion. That is a category that, while it's exceedingly high, I don't have nearly the same level of confidence about its probability of closing. But when you translate all of that, I would go back to the answer 5 minutes ago is that I don't expect us to grow 12%, even in the first quarter or for all of 2018, but I do expect it to be at the high end of single digits, 8%, 9%.
Got you. Okay. That's helpful. And then just the last 2 were the fee income. Just kind of the -- when you strip out the gains this quarter, the security side kind of being around the $18 million level, Mark, I mean, is that kind of a decent way to think about as you enter '18 that, that run rate or in kind of ramping up the net level is how to think about the fee income side of things?
Yes, I mean, that's a low point. We have a lot of volatility that comes through a couple of different categories, primarily the hedging and what happens in BOLI. And so we think of our run rate as being higher than at '18. And it's usually from that volatility. So the fourth quarter was relatively light in both areas.
Okay. I got you. And then last one was just where the CRE and C&D concentration levels today kind of now that you've got everything kind of folded in and -- I mean, can you just give any color on kind of where it's sitting today?
Yes, Brian. If you look on the bottom of Page 20, we have it. Yes, no. It's -- we have it compared and it's lines 12 and 13. It's the 60% for the C&D and 219% for the total CRE.
This concludes our question-and-answer session. I would like to turn the conference back over to Mike Rechin for any closing remarks.
I really have very few. I appreciate everyone's interest in listening to the progress of First Merchants. Thought it was a really strong year for us. We're pleased about that. But also, we're equally pleased to tackle 2018. Look forward to talking to you in 3 months.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.