First Merchants Corporation

Good afternoon and welcome to the first Merchants first quarter 2020 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note today's event is being recorded. This presentation contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act. Such forward-looking statements can be identified by the use of words like believe, expect, or may, and include statements relating to First Merchants' business plan, growth strategies, loan and investment portfolio, asset quality, risks, and future costs. These statements are subject to significant uncertainties that may cause results to differ materially from those set forth in such statements, including changes in economic conditions, the ability of first merchants to integrate recent acquisitions, changes in regulations, and requirements of the company's regulators, litigation, changes in the creditworthiness of customers, fluctuations in market rates of interest, and other risks and factors identified in first merchants' filings with the Securities and Exchange Commission. First Merchants undertakes no obligation to update any forward-looking statement, whether written or oral, relating to the matters discussed in this presentation or press release. In addition, the company's past results of operations do not necessarily indicate its anticipated future results. I would now like to turn the conference over to Mike Rechin, President and CEO. Please go ahead.

Thank you, Andrea. And good afternoon, everyone. Welcome to our earnings conference call and webcast for the first quarter ending March 31st, 2020. Joining me today are Mark Hardwick, our Chief Financial Officer and Chief Operating Officer, as well as John Martin, our Chief Credit Officer. Also joining me today is Michele Kawiecki, our Senior Vice President and Director of Finance, who will actually be presenting material later in the presentation. and Mike Stewart, our Chief Banking Officer, is also with us in the event that he can add thoughts to questions later in the presentation. Given the rapidly changing environment, our goal is to provide a thorough review of 2020's first quarter, coupled with an eye towards first merchants positioning for the balance of the year and into 2021. We released our earnings in a press release this morning at approximately 8 a.m. Eastern Time, and our presentation speaks to material from that release. The directions that point to the webcast were also contained at the back end of that release, and my comments begin on page four, a slide titled First Quarter 2020 Highlights. First merchants earned earnings per share of 62 cents, net income of $34.3 million, a return on assets of 1.09%. The earnings per share and net income compare with Last year's first quarter of 78 cents and net income of $38.8 million. Total assets grew to $12.7 billion, 24.3% over the first quarter of 2019. And the growth was a function of our third quarter 2019 acquisition of Monroe Bank and Trust, coupled with the organic growth on the next line down. Loan growth is 7.9%, deposit growth of 8.9%, respectively, from last year's first quarter. Through the course of John Martin's discussions, you'll hear about loan demand as we see it through the first quarter and a little bit of our pipeline as we move forward in an unusual time period. We recorded $19.8 million of provision in the first quarter, and coupled with less than $600,000 in net charge-offs, Our reserve increased 23% from year end, which is about the same rate of growth from 331 of 19. Mark and Michele will have further comments on the provision composition and the reserve level in their presentations. Our common tangible equity to assets totaled 9.91%, and back to the allowance for a second, the allowance plus fair value marks totaling 1.54% of loans at March 31st. With the quarter's earnings, our tangible book value increased to $22.46, an 11.9% increase over 2019. Before Mark speaks in greater detail on our results, I'd like to summarize a few perspectives on our actions over the last 45 days. And so on page five, I have a page that describes First Merchants supporting our employees' health and financial stability. and the top couple bullet points speak to the fact that with over 1,850 teammates, we've enabled over 1,000 of them to work from home, have the technology to be both available and effective. We provided an additional 80 hours of paid time off for flexibility purposes for our full-time associates for COVID-related sick and dependent care, the flexibility needed as changes occurred on short notice. The bottom points really just speak to a culture of high-touch communication with both individuals and the entire company for a rapidly changing set of needs. I'm going to move to page six, a couple comments on our support of the business community. And up top is kind of the highlight program of the last month as it relates to business clients. We find ourselves in between two Congress-approved fundings. and then most of the bullet points here speak to the wave that is just in the process of getting boarded onto our balance sheet as we speak. Desirable program for a business banking and commercial lending oriented middle market organization and so we had great demand as is evidenced in the top point. Greater than 3,750 applications and greater than $750 million funded to businesses benefiting more than 120,000 employees. in parentheses, you can see that the company brought experience with the SBA programs into the new product announcements. John's going to cover it later, but as of March 31st, we had over $200 million in commercial loan modifications, approximately 3% of the portfolio, and the modification discussions with our clients have gone on. John's going to bring you up to speed later on as to where it was on a more current time period across all the lines of business. Right ahead of us, we have a team of bankers evaluating and preparing other aspects of the CARE Act, specifically the rollout of the Main Street Lending Program to support larger businesses. We know that guidance is due soon. We'll be ready to measure the attractiveness of that to our clients relative to our delivery. Had a strong first quarter, and the second bullet point from the bottom just talks about funding general working capital growing. John may make a comment that we didn't have. Large run-ups on line draws, and he'll have some material to exhibit that point. We've offered and are seeing wider use of commercial client technology to maintain operating routines of our commercial clients. And the bottom bullet point with heavier use of remote deposit capture devices in the field and wire modules being used by all of our clients. I'm going to move to page 7. Additional First Merchants Response, top bullet point, a board-approved action of an $1 million contribution commitment to impacted first merchants markets through local not-for-profit organizations. We're going to be giving back to frontline organizations who are critical in addressing the most basic needs in the markets that we serve. A couple of bullet points around modified delivery. And so the clients have really adapted quite well to alternative delivery of consumer banking with drive-through transactions and lobby service still available on an individual meeting basis by appointment. It's been a great opportunity to highlight our technology, and so our investments over the last couple of years have seen increased digital banking use as our call center, taking thousands of calls and steering our clients towards their best avenue to have their needs met. multiple channels working in sync to satisfy the needs and answer questions. John's going to talk at length and quantify all of the modification requests, but on this page, consumer and mortgage loan payment deferrals granted on a case-by-case basis up to 90 days without incurring any fees or any credit reporting. Hardship Bridge Loans was an early first merchants program, even before the CARES Act, Just to recognize that we had consumer customers that had needs on what the hardship began to evidence. It's been useful for us throughout our banking centers and consumer clients. And then lastly, sharing knowledge and encouraging caution. I think we've seen nationwide that there's been a higher incidence of fraud attempts and COVID-related scams, and so we're trying to protect our clients through this difficult period. With that having been said, I'll join you later, but Mark wants to get a little bit deeper into our first quarter results.

Thank you, Mike. My comments will begin on slide nine where total assets on line seven increased by $2.5 billion or 24.3% since the first quarter of 2019. Investments on line one increased by $835 million or nearly 45% during the same period due to strong deposit growth and acquired liquidity. while loans on line two increased by $1.3 billion or 17.9%. Acquired loans accounted for $733 million of the $1.3 billion in loan growth, leaving organic growth to account for $577 million or 7.9% of our growth. Additionally, on line three, the allowance for loan losses increased by 18 million or 22.2% over the first quarter of 2019, primarily due to COVID-related provisions during the first quarter of 2020. The composition of our $8.6 billion loan portfolio shown on the upper right of slide 10 produced a yield for the quarter of 4.85%. Loan yields are under pressure given the 150 basis point decrease in the prime lending rate during the quarter and the trailing impact that it's had on LIBOR as well. As the graph on the right illustrates, 67% of our loans are variable with half for pricing daily. Our loan yield of 485 is down from last year's peak of 5.32%. On slide 11, our investment portfolio. has a longer duration than peer, which is a good offset to our variable rate loan portfolio. And as of March 31, 2020, our unrealized gain totaled $121.7 million, a $95.6 million increase since this time last year. You will also see meaningful realized gains on the sale of securities when I cover slide 16 due to strategic movements within sectors of our investment portfolio to both take advantage of gains and improve yields. On slide 12, total deposits increased by $1.8 billion or 22.6% over the first quarter of 2019. Monroe Bank and Trust accounted for $1.1 billion of the growth while organic deposits grew by $717 million or an annualized 8.9%. Common equity on line seven increased by $322 million from the first quarter of 2019 to the first quarter of 2020. Beyond normal earnings and dividends and other comprehensive income changes, the 100% stock purchase of Monroe Bank and Trust that we closed back in September of 2019 increased equity by $230 million, and the completion of our announced share buyback program decreased equity by $75 million. The company repurchased just over 2,150,000 shares over the duration of the program. Capital and liquidity are positioned well for the future, and management is pleased with the structure of our balance sheet. as we enter this recessionary environment. We believe that our loan-to-deposit ratio of 87% and our loan-to-asset ratio of 68% provides the bank with fortress balance sheet levels of liquidity. The mix of our deposits on slide 13 is the key to both liquidity strength and low-cost funding. First quarter interest-bearing deposit costs totaled 106 basis points down from last year's peak of 133. When we include non-interest bearing demand deposits, our interest expense for the quarter totaled 88 basis points. All regulatory capital ratios on slide 14 are above the regulatory definition of well capitalized and are internal targets which ensure the bank maintains fortress-like levels of capital. Now let's turn to slide 15. The corporation's net interest margin, net of fair value, declined by an additional 10 basis points from the fourth quarter of 2019 to the first quarter of 2020. This chart, going back to the first quarter of 2018, highlights the asset-sensitive nature of the bank's balance sheet. As the Fed funds rate started this two-year journey at 150 basis points, increased, to 250 basis points during the peak of our margins near the end of 2018 and then declined by 225 basis points including this last 150 basis point decrease in the first quarter of 2020 to just a quarter point. Despite the quick and decisive action around deposit rates in 2019 and the first quarter of 2020, and additional upcoming city maturities during the remainder of 2020, we anticipate some additional net interest margin compression again next quarter. Staying with the two-year timeline for a moment, in the first quarter of 2018, our loan-to-deposit ratio was 94%, and now it's just 87%. Our liquidity is healthy in this recessionary environment, but challenges margin. We've essentially traded illiquid loan yields of 4.85% for liquid bond yields of 3.16% on approximately $710 million of earning assets over this two-year period leading up to the current recession. Non-interest income on slide 16 totaled $29.8 million as of March 31, 2020, an increase of $11.1 million or 59%. primarily due to the acquisition of Monroe Bank and Trust. Additionally, several items in the category provide a natural hedge to the bank's net interest income by growing when rates decline and declining when rates rise. Customer specific line items accounted for 7.3 million of the increase to include growth in fiduciary and wealth management fees of 2.2 million, gains on the sale of mortgage loans increased by 2.1 million, Derivative hedge fees and card payment fees, two separate line items here, increased by $1.1 million each and service charges increased by $900,000 for the quarter. Non-interest expense on slide 17 totaled $66.1 million in the first quarter of 2020 compared to just $56.6 million in the first quarter of 2019. Of the increase, our merger with Monroe Bank and Trust accounted for nearly all of this change. I should also add that post-integration, which we completed in November of 19, we have achieved all of our announced cost savings that were part of our original targets. Now on slide 18, as Mike mentioned in his opening remarks, the decline in both net income on line 8 and EPS on line 9 were primarily the result of provision expense on line 2. Additionally, despite margin pressure, the efficiency ratio on line 10 remained at an impressive 52%. On slide 19, you can see trends of EPS, dividends, and tangible book value per share. And on slide 20, you will notice our total compound annual growth rate of tangible common equity is still over 10%, totaling 10.12%, and our dividend yield is nearly 4%. Now Michele Kawiecki, our Senior Vice President of Finance, will cover a couple of key items related to the CARES Act and their impact on our financial statement.