First Merchants Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
July 25, 2024

There are 10 speakers on the call.

Operator

Thank you for standing by. And we'll go to the First Merchants Corporation's 2nd Quarter 2024 Earnings Conference Call. Before we begin, management would like to remind you that today's call contains forward looking statements with respect to the future performance and financial condition of First Merchants Corporation that involve risks and uncertainties. Further information is contained within the press release, which we encourage you to review. Additionally, management may refer to non GAAP measures, which are intended to supplement but not substitute for the most directly comparable GAAP measures.

Operator

The press release available on the website contains financial and other quantitative information to be discussed today as well as the reconciliation of GAAP to non GAAP measures. As a reminder, today's call is being recorded. I will now turn the call over to Mr. Mark Hardwick, CEO. Mr.

Operator

Hardwick, you may begin.

Speaker 1

Good morning, and welcome to the First Merchants' Q2 2024 conference call. Thanks for the introduction and for covering the forward looking statement on Page 2. We released our earnings today at approximately 8 am Eastern Time. You can access today's slides by following the link on the 3rd page of our earnings release. On Page 3 of our slides, you will see today's presenters and our bios to include President, Mike Stewart Chief Credit Officer, John Martin and Chief Financial Officer, Michelle Kebiezki.

Speaker 1

On Page 4, we have a few financial highlights for the quarter to include total assets of 18,300,000,000 dollars 12,700,000,000 of total loans, dollars 14,600,000,000 of total deposits and $9,300,000,000 of assets under advisement. On Slide 5, net interest margin and net interest income increased during the quarter. Net interest margin increased by 6 basis points and net interest income increased by $1,500,000 We also had meaningful improvements to non interest income and non interest expense that when coupled with net interest margin improvements helped push our efficiency ratio below our key performance indicator of 55% totaling 53.84% during the quarter. Loan growth totaled 6.1% for the quarter and we have now substantially completed all 4 of our major technology initiatives for the year. On a less positive note, our provision expense totaled $24,500,000 for the quarter.

Speaker 1

We previously financed the sale of a business from one long time owner and his second to his second in command based on a substantial and consistent EBITDA. Due to competition and the renegotiation of material contracts, the business has experienced significant deterioration in its performance, which ultimately resulted in our 10 Q subsequent event footnote on May 1 in this quarter's charge off. Despite the heightened level of provision expense this quarter, our earnings power produced growth of capital and took tangible book value per share. Our capital position allowed for the repurchase of another $20,000,000 of stock and the redemption of $25,000,000 in the expensive sub debt. Earnings per share totaled $0.68 per share in Q2 and through 6 months, EPS totaled $1.48 per share.

Speaker 1

Now Mike Stewart will discuss our line of business momentum.

Speaker 2

Thank you, Mark, and good morning to all. Our business strategy summarized on Slide 6 remains unchanged. We are a commercially focused organization across all these business segments and across our primary markets of Indiana, Michigan and Ohio. As we entered 2024, we remain focused on executing our strategic imperatives, specifically organic growth of clients through loans, deposits and fees, engaging, rewarding and retaining our teammates and investing in the digitization of our delivery channels. These remain the focus for the balance of 2024.

Speaker 2

So let's turn to Slide 7. The 2nd quarter continues the choppy trend of loan growth from quarter to quarter. We experienced over 6% growth on an annualized basis during Q2. This followed the flat Q1 and the 8% growth we experienced in the Q4 2023. During this quarter, the commercial portfolio experienced very strong C and I growth more than 13%.

Speaker 2

The growth was shared across the regions with Indiana and Ohio joining Michigan and the sponsor teams in driving year to date growth to the high single digits. Our commercial focus has always been the primary driver of our balance sheet growth and the commercial and industrial sector is our largest portfolio. C and I comprises 50% of the total first merchants loan portfolio and 2 thirds of the commercial. Business owners within our markets continue to execute their operating plans with growing working capital, equipment and acquisition needs. Our commercial bankers continue to support those companies not only with capital solutions, but also with treasury solutions.

Speaker 2

Overall, we continue to gain market share through our clients and with prospect conversions. Those two attributes, economic growth and market share growth are the primary drivers of the continued growth of C and I. The strong C and I growth was muted by the contraction within the investment real estate portfolio. The stabilization of construction projects has continued and our clients have chosen to either sell their projects, taking advantage of attractive cap rates or refinance their projects into the permanent market, taking advantage of low long term interest rates. We have experienced a higher than normal runoff in 2024 primarily with the multifamily asset class.

Speaker 2

The backlog of projects reaching stabilization this year is simply one of timing. A preponderance of projects that started post the pandemic needed to absorb the higher interest rates while achieving higher rents. All these payoffs are normal course for construction projects with 2024 reflecting higher activity. New project volumes are at healthy levels. With consistent underwriting and strong syndication efforts, our investment real estate team has earned mandates for future projects.

Speaker 2

Our clients appreciate our consistent approach to underwriting through cycles and the newly awarded construction projects are primarily within the multifamily, industrial and warehouse asset classes. This new volume will begin to set the floor on investment real estate footings for the balance of this year with growth expected into 2025. The second bullet point further emphasizes the future growth potential within the commercial portfolio. Both the C and I and IRE pipelines ended the quarter at higher levels than at the end of March and at the end of June of 2023. I wanted to reference our fee income businesses within the commercial line, specifically treasury management fees.

Speaker 2

Treasury fee income grew more than 10% during the quarter and over the prior year. Several factors are driving that growth. New client conversion and the successful rollout of the new treasury platform to 2Q that Mark just referenced. So we've got the enhanced fee structures moving through the enhanced product platform set. And we will complete the phased rollouts of this platform and the periphery products in the Q3.

Speaker 2

The loan outlook for the balance of the year remains at a high single digit rate with fee income growing at a double digit level. The consumer portfolio is comprised of residential mortgage, HELOC, installment and private banking relationships. During the Q2, the consumer portfolio grew more than 10% in dollars that represented a $75,000,000 increase. The private banking portfolio was the primary driver of the increase, joining the consumer mortgage and small business growth as well. As noted, the consumer loan pipeline remains strong heading into the 3rd quarter.

Speaker 2

A few comments on deposit balances during the quarter. Total deposit decline was a mix of normal seasonality and interest rate management. Historically, the 2nd quarter is the lowest level of deposit balances with a build that continues through the end of the year. I stated last quarter that we have that now that we've had separation from the Silicon Valley event and as our bank's liquidity remain ample, we will focus on margin with interest expense being the key driver. With higher expectations of a Fed rate cut in the back half of twenty twenty four, we began to reduce our money market CD specials, while also reducing the tenor of new CDs.

Speaker 2

The largest balance decline was within the time deposit category. Further, with the shortened maturities, we can continue to reprice the time deposit book in sync with any Fed rate reduction. Noted on the first sub bullet point, consumer deposits continue to grow on a year over year basis, greater than 4%. Total deposit balances from prior year are flat. I also want to note that deposit balance have shown strong growth through the month of July as the seasonal build occurs and organic growth in units continue.

Speaker 2

So I'm going to turn the call over to Michelle now to review in more detail the composition of our balance sheet and the drivers of our income statement. Michelle?

Speaker 3

Thanks, Mike. Slide 8 covers our 2nd quarter results. Pretax pre provision earnings totaled 68,500,000 Pre tax pre provision return on assets was 1.49% and pre tax pre provision return on equity was 12.43%, all of which reflects strong profitability metrics. We continue to grow tangible book value per share, which increased to $25.10 at June 30. Slide 9 shows the year to date results with pretax pre provision earnings totaling 128,700,000 dollars pre tax pre provision return on assets of 1.4 percent and pre tax pre provision return on equity at 11.58% year to date.

Speaker 3

Tangible book value per share increased $1.76 or 7.5% compared to the same period of prior year. Lines 1 through 3 at the top of the page show that we continue to grow the balance sheet and remix earning assets, reducing the lower yielding portfolio by $138,000,000 since June 30 last year and growing higher yielding loans by 374,000,000 dollars Details of our investment portfolio are disclosed on Slide 10. The securities yield increased 3 basis points to 2.61 percent as lower yielding securities continue to run off. Expected cash flows from scheduled principal and interest payments and bond maturities in the next 12 months totals $286,000,000 with The total loan portfolio yield increased by 4 basis points to 6.72%. We've been able to maintain a high yield on new and renewed loans at 8.13%.

Speaker 3

That yield was 8.15% last quarter. The bottom right shows the 2 thirds of our loan portfolio's variable rate, Although some of those loans are priced at or near our new loan yield currently, we still have loans continuing to reprice up creating good incremental interest income throughout the remainder of the year. The allowance for credit losses is shown on Slide 12. This quarter we recorded net charge offs of $39,600,000 which was offset by provision for credit losses on loans of $24,500,000 resulting in a reserve at quarter end of $189,500,000 In addition to that, we have $20,300,000 of remaining fair value marks on acquired loans. Our coverage ratio declined from 1.64% in prior quarter to 1.5% this quarter and is 1.66% when including those loan marks.

Speaker 3

Although the coverage ratio declined some, we are still more than adequately reserved as our allowance remains well above peer levels. Slide 13 shows details of our deposit portfolio. We continue to have a diversified core deposit franchise with a low uninsured deposit percentage. Notably this quarter, our yield on interest bearing deposits was flat compared to prior quarter at 3.16 percent and the cost of total deposits only increased 2 basis points to 2.66% this quarter, reflecting the pricing actions we took in the last 6 months that Mike Stewart mentioned earlier. Additionally, non interest bearing deposit balances and deposit mix were stable quarter over quarter.

Speaker 3

Although we did leverage some wholesale borrowing, we paid down another $25,000,000 of high cost sub debt at the end of April, which helped reduce the overall funding cost of the company. On Slide 14, net interest income on a fully tax equivalent basis of $134,400,000 is an increase of $1,500,000 from prior quarter, which was the result of growth in interest income and a decline in interest expense. Yield on average earning assets on Line 4 increased 4 basis points. Funding costs on Line 5 declined 2 basis points resulting in the expansion of stated net interest margin of 6 basis points. Next, Slide 15 shows the details of non interest income.

Speaker 3

Overall, non interest income increased by $4,700,000 on a linked quarter basis. Customer related fees increased $3,300,000 reflecting higher gains on sales of mortgage loans and private wealth fees. The Q1 of each year is always seasonally low for our mortgage business and the production rebounded in the 2nd quarter as expected. We believe the 2nd quarter mortgage production levels will continue throughout the coming quarters. Included in non interest income was a $1,400,000 increase in the valuation of CRA investments that were recorded in other income.

Speaker 3

Even when excluding that valuation adjustment, our core non interest income results were slightly above the guidance we provided last quarter. Moving to Slide 16, non interest expense for the quarter totaled $91,400,000 beating expectations and improving operating leverage. Workforce cost declined $6,100,000 which was driven by savings generated from the voluntary early retirement program that we announced in the Q4 of last year as well as lower incentive accruals. FDIC assessments were also lower this quarter due to the inclusion of an increase to the FDIC special assessment accrual booked in the prior quarter. Slide 16 shows our capital ratios.

Speaker 3

We continue to have a strong capital position with common equity Tier 1 at 11.02%, which included a dividend increase to shareholders declared in the 2nd quarter and a dividend payout ratio of over 40%. The slight decline in each of our ratios since year end reflects the $65,000,000 redemption of sub debt and $50,000,000 of stock buybacks since the beginning of the year. These capital actions demonstrate prudent capital management and provide a good return for shareholders. That concludes my remarks and I will now turn it over to our Chief Credit Officer, John Martin to discuss asset quality.

Speaker 4

Thanks, Michelle, and good morning. My remarks start on Slide 18. I'll begin by highlighting loan portfolio growth, touch on the updated insight slide, review asset quality and the non performing asset roll forward before turning the call back over to Mark. Turning to Slide 18, we had a strong quarter of growth in commercial and industrial loans, including owner occupied CRE on lines 123 that more than offset the decline in construction and CRE non owner occupied or investment real estate on lines 45. Our C and I growth was aided by new loan requests as well as higher line utilization.

Speaker 4

Our investment real estate strategy on prior calls, is one where we provide construction finance through stabilization with many firm financing options. We continue to remain well below the regulatory CRE concentration levels and remain active in new originations. This quarter, we saw greater movement out of the construction on Line 4 and into our portfolio on Line 5, roughly 75% of the decline in the construction and non owner occupied categories resulted from refinances into bridge or agency products. And I think this speaks favorably to continued market demand for our underwriting. Then moving to Slide 19, the loan portfolio insight slide is intended to provide transparency into the portfolio.

Speaker 4

As mentioned on prior calls, the C and I classification includes sponsor finance as well as owner occupied CRE associated with the business. Our C and I portfolio has a 20% concentration in manufacturing. Our current line utilization increased for the quarter from 42% to 45.3 percent or roughly $236,000,000 in new balances with line commitments higher by roughly $200,000,000 We participate in roughly $830,000,000 of shared national credits across various industries. These are generally relationships where we have access to management and revenue opportunities that go beyond the credit exposure. In the sponsor finance portfolio, I've highlighted key credit portfolio metrics.

Speaker 4

There are 84 platform companies with 52 active sponsors in an assortment of industries. 65% have a fixed charge coverage ratio of greater than 1.5 times based on Q1 borrower information. This portfolio generally consists of single bank deals for platform companies, of private equity firms as opposed to large widely syndicated leverage loans from Money Center Bank Trading Desk. We review the individual relationships quarterly for changes in borrower condition, including leverage and cash flow. These are merely C and I customers owned by private equity firms.

Speaker 4

Turning to Slide 20, where we break or non owner occupied commercial real estate portfolio. Our office exposure is detailed on the bottom half of the slide and represents 1.9% of total loans, down slightly from 2% last quarter, with the highest concentration outside of general office in medical office space. The wheel chart on the bottom right details office portfolio maturities. Loans maturing in less than a year represent 16.3% of the portfolio or $39,600,000 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 as reasonably mitigated through a combination of LTV guarantees, tenant mix and other considerations.

Speaker 4

On Slide 21 are the quarter's asset quality trends and position. Non accrual loans, other real estate owned and 90 days past due loans all decreased for the quarter, down in total from $70,200,000 to $68,400,000 This represented a decline for the quarter resulting from significant charge offs. Net charge offs were $39,900,000 in the quarter, primarily resulting from 2 relationships. The first was related to last quarter's subsequently disclosed event. The loan was a part of a larger 2 bank club deal where First Merchants as lead bank financed the management buyout of the business.

Speaker 4

We had been monitoring the borrower's progress over the last several quarters to renegotiate and renew various freight hauling contracts with the U. S. Government As a result of unexpectedly lower contract renewal rates and contract cancellations, we were informed by the borrower after last quarter's call that they plan to discontinue repayment of principal and interest. This event triggered the disclosure and our analysis of loss. While the loss the loan had some collateral, underwriting was based on historically consistent cash flow and the enterprise value of the organization.

Speaker 4

With the sudden change in revenue resulting from the cancellation or renegotiation of the contracts, the company's value was negatively impacted resulting in the $27,500,000 charge. The 2nd borrower, a C and I home decor manufacturing company had been struggling since the pandemic and notified of its plans to cease operations. We had previously reserved for the potential loss and took the $8,600,000 charge off this quarter when notified of the borrower situation. Then moving to Slide 22, where I've again rolled forward the migration of the non performing loans, charge offs ORE and 90 days past due. For the quarter, we added non accrual loans on line 2 of $51,600,000 driven by the transportation manufacturing company I just mentioned, there was a reduction from payoffs or changes in accrual status of $11,200,000 on line 3 and a reduction from gross charge offs of $40,900,000 then dropping down to line 11, 90 day delinquent loans decreased by $1,100,000 which resulted in NPAs plus 90 day delinquent loans ending at $68,400,000 So to summarize, C and I loan growth was good for the quarter.

Speaker 4

Commercial real estate is feeling some effect from higher interest rates, although our underwriting continues to positively cycle construction loans to the portfolio and the permanent market. And finally, we experienced idiosyncratic net charge offs in the quarter that don't appear to be part of a larger trend. I appreciate your attention and I'll turn the call back over to Mark Hardwick.

Speaker 1

Thanks, John. Turning to Slide 23, on the top right, you can see our 10 year earnings per share compound annual growth rate totals 10.2%. And on the bottom left, our tangible book value per share, excluding other accumulated other comprehensive loss, now totals $28.71 Slide 24 represents our total asset CAGR of 12.3% during the last 10 years and highlights meaningful acquisitions that have materially added to our demographic footprint that fuel our growth. There are no edits to Slide 25 as we continue to live both our vision and our strategic imperatives. We're looking forward to a stronger Q3 led by balance sheet and net interest income growth and normalized levels of provision expense.

Speaker 1

Thank you for your attention and your investment in First Merchants and now we're happy to take questions.

Operator

Our first question comes from the line of Daniel Tamayo from Raymond James.

Speaker 5

Thank you. Good afternoon, guys. Maybe actually, I'll leave the credit questions for others. But just starting on the margin, Michelle, I'm looking at the commercial loan yields being relatively stable over the last couple of quarters. Just curious where the new loan yields are in that book And then if you see any kind of incremental increase going forward absent rate cuts?

Speaker 5

And then follow on that one, just curious like the fixed rate book versus new yields, what may be the potential opportunity for loan yields as a whole to increase over time? Thanks.

Speaker 3

Yes. It's good to hear from you, Danny. So for our loan yields, our new and renewed loan yields this quarter was 8.13%. So we've kind of reached some stabilization, at a really nice high yielding place, I think. We do have, I think, some opportunity for the book to reprice up just a bit.

Speaker 3

We've got probably about $450,000,000 of fixed rate loans yet that would reprice in 2024 and they're averaging somewhere in between 5% 6%. So I still think there's some opportunity to gain some interest income on that repricing and potentially push the overall portfolio yield up a bit.

Speaker 5

Okay, great. And then I guess on the other side of the balance sheet, so curious for the any opportunity to reduce borrowings further and then your deposit costs basically stabilized in the quarter, which is great. You talked through the reductions that you had in the money market book. But just curious kind of how you're thinking about funding costs going forward. And I guess overall then if you have thoughts on where the margin can move, I guess, independent of rate cuts and then what the impact from rate cuts would be?

Speaker 3

Yes. We were really pleased with the results on deposit costs this quarter. We've even seen deposit costs go down, which is just like you said, the result of some of the interest rate management that we've been doing with our deposit customers. I feel like that work that we've done is kind of been done. I feel like now it's just a matter of looking at what competition does from here until the end of the year.

Speaker 3

And so I think our deposit costs should be stable. Looking at margin through the end of the year, assuming a flat rate environment, I would expect that we would still see some margin expansion. It will be stable at the minimum, but perhaps some expansion as well. We do have CDs that are repricing, but those the rate at which they're repricing is actually either similar or even just a slightly bit higher than our promos today. And so, it's not that we really have a headwind there, but or a tailwind there, but we certainly don't have a headwind on that book.

Speaker 3

And so that's good news. And so I think margin, assuming a flat rate environment ought to be stable to up.

Speaker 5

Great. And just remind us if you will on how you think rate cuts would impact that forecast?

Speaker 3

Yes. So our models tell us that with each 25 basis point rate cut, we would have a decline of about 3 basis points in margin.

Speaker 5

Okay. All right. Terrific. Thanks for all the color, Michelle.

Speaker 6

Welcome.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Damon Delmont from KBW.

Speaker 6

Hey, good morning everyone. Hope you're all doing well and thanks for taking my questions. Just wanted to start off on expenses, Michelle. You noted that decline in the salary benefits line item reflected the impact of some voluntary retirement and other items. Do you think that this kind of low $52,000,000 range is sustainable?

Speaker 6

Or would you expect kind of some normalization there and see that creep back up to maybe the $55,000,000 range?

Speaker 3

No, I would expect the expenses to be somewhere between where we landed this quarter to maybe up 2%, somewhere in that range. And we had great expense discipline this quarter and I think we'll continue to do so through the remainder of the year.

Speaker 6

Okay. And that's for total expenses, not just the salary and benefits line?

Speaker 3

Correct.

Speaker 7

Okay, great.

Speaker 6

And then with regards to fee income, if you back out the CRA adjustment that you had or realized gain there, do you think you can kind of keep the fee income in that in the low $31,000,000 to $32,000,000 range kind of in the back half of the year?

Speaker 3

Yes, I do think that's a good run rate.

Speaker 6

Okay, great. And then just lastly on just more on the provision versus the overall credit. Do you feel comfortable with the reserve? Obviously, $150,000,000 is pretty healthy. Do you think that you're going to see some natural drift there over the back half of the year and that the provisioning would kind of go back to what we've seen in the last couple of quarters ex this quarter?

Speaker 3

Yes, I think we'll definitely be providing for loan growth, to make sure that we've got good coverage with any growth that we have. And then we'll just have to see what the forecast, how the forecast impact our model. But we're expecting provision to normalize this quarter obviously was very unique.

Speaker 6

Okay. That's all that I had. Thank you.

Speaker 3

Thanks Damon.

Operator

Thank you. Our next question comes from the line of Terry McEvoy from Stephens Inc.

Speaker 8

Hi, good morning everyone. John, I know you used the word idiosyncratic to talk about the credit events last quarter, though transportation is your 3rd largest non accrual and was behind the charge off. So could you talk about a recent review of the portfolio? I think it's about 4% of C and I loans or transportation warehouse and what your thoughts are going forward in terms of the underlying risk?

Speaker 4

Yes, we've I pulled out the transportation concentration as you point out, it's 4%. The transportation portfolio in general, I don't have the specific criticized or classifieds within that book. But what I would say is that absent this one rather large credit, most of our lending within that space is secured non transactional leveraged or buyout finance. And the remaining balances in that book are generally trailers and PTOs related to trucking operations. The general freight hauling industry in general, it has experienced some stress with lower rates over the more recent past.

Speaker 4

But this particular and why I say it's idiosyncratic is because of the unique nature of this hauler in particular. This is a freight hauler that had contracts with the government versus the general freight hauling industry. The customer was, I think as it was had the renewal of the contracts was somewhat well, it was definitely unexpected from the borrower's perspective. So this being idiosyncratic compared to what my evaluation would be of the general transportation segment within our portfolio.

Speaker 8

Thanks. And then, Mike, just Slide 18, just so I'm clear, on Line 4 and 5, the decline in construction land development and non owner occupied CRE, that's more of a reflection of kind of market conditions versus a strategic decision to reduce those portfolios? And did you say you'd expect some growth to balances to move higher in the back half of twenty twenty four?

Speaker 2

You're correct. There was no strategic change in how we're managing an investment real estate book. It was just all the way the normal process went for us and where the concentrations were with or the maturities were inside that portfolio. Our IRE activity quite frankly for the 1st 6 months of the year has been very, very strong with good sound projects in those spaces And you're just not seeing that come through footings yet. And that's what I was saying.

Speaker 2

I think that we're probably at putting that floor in on IRE footings that will then put in growth into next year in that sector. But it's not a strategic change, consistent underwriting. Our key clients continue to come to us with their projects and capitalize them well and we like the underwriting.

Speaker 8

Maybe one last question for Mark. I don't want to overlook the last major technology initiative of the year was completed last quarter. You maybe talk about how much of that was self funded through reduction in real estate and employees, etcetera? And I guess strategically, how does that better position First Merchants in the marketplace to grow organically and service customers?

Speaker 1

Yes. The last item was is the conversion or has been the conversion of our online and mobile platform for commercial customers. And so it's an area where we're really excited to finally have more state of the art technology. We were using FIS and had continuously kind of waited on an upgrade of their core system in that space and ultimately kind of gave up and decided to go hire a 3rd party vendor Q2 to help us with that work. And so, as much of a commercial bank as we are, we had a bit of an inferior treasury management product.

Speaker 1

And so as Mike said in his remarks, which I thought was really well put, we've enhanced our fees, increased our fees and we've enhanced the product and really feel like we have an opportunity to win in that space at a level that we've never really experienced, which is exciting for us. And then the way it was funded really was just from the elimination of the cost we were spending with FIS. There was virtually no difference in the expense from using our core provider kind of the old bank in the box mindset as a core platform, online and mobile platform with FIS and moving to Q2, where we did have some expenses just around the conversion itself, which we've called out as one time last quarter and had a modest amount of it in this quarter. I didn't think it was worth really covering. But really excited to be on the back end of 4 major technology initiatives.

Speaker 1

I think Mike has a little more to add as well.

Speaker 2

That's a good question. I'm glad you asked. Mark talked about the commercial side, which we talked about. On the consumer side, the platform investments and bringing the technology into a new place has enabled us to continue to as we monitor where our clients are utilizing our physical infrastructures, our banking centers, we do consolidate banking center locations and this technology and these enhancements continue to allow us to open new accounts and serve their needs and we continue to analyze that infrastructure. And then on the private well side, that new technology platform built some synergies in and there were some people eliminations along the way.

Speaker 2

So to Mark's point, they were self funded on a technology point of view. Some of them turned into true revenue generation and some of them also had expense reductions associated with them and we're on the back half of

Speaker 1

that or the backside of that.

Speaker 9

Perfect.

Speaker 8

Thanks for taking my questions.

Speaker 9

Thank you, Jerry.

Operator

Thank you. Our next question comes from the line of Nathan Race from Piper Sandler.

Speaker 9

Yes. Hi, everyone. Thanks for taking my questions. Just wanted to clarify on Michelle's comments on the margin following each Fed cut. I think you said 3 basis points, but I was just curious if that's under a static scenario or does that kind of contemplate some improvement in mix just as you redeploy securities portfolio cash flow into loan growth?

Speaker 3

Yes, that's actually assuming a static balance sheet.

Speaker 9

Okay, great. So theoretically, the pressure should be less than that 3 basis points from what it sounds like?

Speaker 3

Yes. That would be what we would expect.

Speaker 1

Yes. Internally, we've talked about how that remix could happen or also just what does competition do. We've been living in an inverted yield curve environment for a couple of years. I'd like to think if we have a rate reduction that across the industry we're making deposit rate reductions.

Speaker 9

Got you. And John, can you just clarify just in terms of the 51.6 $1,000,000 in new non accruals in the quarter? It sounds like the bulk of that came from the transportation C and I loan that we talked about. Is there anything else worth calling out that drove that increase?

Speaker 4

No, the 51 point 6, yes, it was a combination of that and the other manufacturer that I mentioned. Those are the 2 biggest drivers of that number.

Speaker 9

Okay, got it. And then just maybe lastly, just thinking about the opportunity or appetite for additional repurchases in the back half of the year. Obviously, activity stepped up nicely here in the second quarter and you guys are still sitting with really strong capital levels and have a nice organic growth runway in front of you, but just curious on how you guys are thinking about that appetite going forward?

Speaker 1

Yes, we were active early in this quarter. I think we'll probably wait to see how the market stabilizes. We were active late Q1, early Q2 And I guess we'll just kind of see how the quarter plays out, but we don't intend to be we aren't active right now, I guess is maybe the best way to put it.

Speaker 9

Okay, got it. And then actually just one last one. Obviously, there's been some increased chatter on the M and A front recently. There was a deal announced in Michigan earlier today. And so just curious kind of what the appetite and interest is in acquisitions going forward?

Speaker 1

Yes, I looked at that this morning. That's a meaningful franchise now when you put those 2 together in Michigan. And I would just say conversations are up. There is clearly a little more interest in terms of seller appetite. And I think given the stock prices are up slightly, the view that rates may be coming down or we're not going to continue to see increases has caused a little more has created a few more conversations.

Speaker 1

But I we have a handful of banks that we're very interested in. When I say handful, maybe 3 or 4 and timing is everything. We'll see if anything happens with those banks in the near term. Otherwise, we're focused on just running the company and leveraging organic growth, continuing to be efficient and optimizing our capital.

Speaker 9

Okay. That sounds great. I appreciate all the color.

Operator

Thanks Nate. Thanks Nate. Thank you. Our next question comes from the line of Brian Martin from Janney.

Speaker 7

Hey, good morning everyone. That was well said Mark. Just one last one on the M and A. Just if you think about where First Merchants would consider opportunities kind of in footprint, out of footprint, just high level, not saying anything is imminent by that front, but just understanding where, what geographies are important to you today?

Speaker 1

Yes. We're very focused on Indiana, Ohio and Michigan. Those are the markets that have where we're actively communicating with potential partners. And I think that kind of is the extent of it to be honest. We've always had some interest in Kentucky.

Speaker 1

They're just the profile, the number of institutions, especially kind of in the Louisville market are incredibly limited. So the majority of our communication and prioritization are in the states of Indiana, Ohio, Michigan.

Speaker 7

Got you. And is it more, I mean, preference wise, Mark, more new entering to a new market or just more scale or either one doesn't matter?

Speaker 1

I mean, they both have it depends. If we could create scale and really have a meaningful expense cost or expense or cost take out, it's interesting to us. And if there were a market where we could help accelerate our future growth rate, that's important as well. So I guess just trying to balance the 2. And as much as anything make sure that it's the right market with the right culture and that we believe at the end of the day we can create real shareholder value.

Speaker 7

Yes. And I guess timing is everything like you said. So it could be what you want versus what's available. So got you. And then maybe just one for John on credit, John.

Speaker 7

Was there anything in terms I know you gave the classified number, but it didn't sound like anything much. But in terms of special mention, any trends upward or downward are pretty stable in the quarter?

Speaker 4

It's actually been pretty stable. And from a balance standpoint, from a commitment standpoint, it was down a little bit. It feels like it is pretty stable at this point absent obviously for us those two names.

Speaker 7

Yes. Okay. And then just the last one or 2 is maybe for Michelle. Just on Michelle, the bond book, it sounds like that as far as where that bond book lands as far as kind of using the cash flows to fund loan growth, where do you expect to settle in on moving that portfolio down in size? Where do you want to see that trend to?

Speaker 3

Well, typically our historical investments to assets ratio has been somewhere between 15% to 18%. And so for us, I think that still would be a more appropriate landing spot in terms of having an earning asset a go forward earning asset mix. And so we'll continue to let it drift. Last year, we looked for opportunities to sell bonds. We'll continue to do that as well.

Speaker 7

Got you. Okay. And you did say that, I mean, I was going to ask as well on that 3 basis points. I guess when you get to the out cuts after the first potential couple cuts, it seems like you've got more ability to work on that deposit beta and get maybe have that lessen that up a little bit. That's kind of the way to view it.

Speaker 7

If there are successive cuts, the later ones are less impactful in terms of that 3 basis points?

Speaker 3

Yes. Well, I think in our deposit base, we do have about $2,500,000,000 of deposits that are indexed. And so there's certainly there's opportunity to reduce some costs with those first couple of cuts.

Speaker 7

Yes, I got you. Okay. And then the last one I had was just maybe Mike, if you already gave this, can go back and relisten, but I joined late. So the loan pipelines where they were at kind of coming out of the quarter, if you covered it already, I'll go back and listen or if you didn't, if you could cover that, that'd be great.

Speaker 2

No, it's on that slide too, but I don't mind emphasizing it again is that I noted that on the commercial pipeline, both the C and I and the IRE pipelines ended June at higher levels than March and over prior years, so just good momentum and I feel like the maturity of our Michigan market in particular. And then on the consumer side, which includes our mortgage, our consumer mortgage portfolio that too ended the quarter at a high watermark for us. And most of that is the seasonal build and the good trends inside consumer mortgage.

Speaker 7

Got you. Okay. That's perfect. Thank you for covering that again. I appreciate it.

Speaker 7

And thanks for taking the question.

Speaker 3

Thanks, Brian.

Operator

Thank you. This concludes today's conference. Thank you for your participation and have a great

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Key Takeaways

  • Net interest margin rose 6 basis points and net interest income increased $1.5 million in Q2, driving an efficiency ratio of 53.84% and EPS of $0.68.
  • Loan growth was robust with total loans up 6.1% annualized, led by a 13% increase in commercial & industrial lending and over 10% growth in the consumer portfolio.
  • Provision expense totaled $24.5 million and net charge-offs were $39.6 million due to two isolated charge-offs, while nonperforming assets declined and coverage ratios remain well above peers.
  • Cost of deposits stayed near 2.66% as total deposits held flat year-over-year and management used CD pricing and tenor adjustments to protect margin ahead of expected Fed cuts.
  • CET1 capital was 11.02% as the bank repurchased $20 million of stock, redeemed $25 million of sub debt, and completed four major technology initiatives—including a new commercial treasury platform—to support future growth.
AI Generated. May Contain Errors.
Earnings Conference Call
First Merchants Q2 2024
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