First Merchants Corporation

Good day everyone and welcome to the first Merchants Second Quarter 2020 Earnings Conference Call. All participants will be in a listen-only mode. If you need assistance, you may see no conference specialist by pressing the star key followed by zero. 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 often be identified by the use of words like believes, and include statements relating to first merchant's goals, business plan, growth strategies, loan and investment portfolio, asset quality, risks and future costs and benefits. 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 and business conditions, The ability of first merchants to integrate recent acquisitions and attract new customers, changes in laws, regulations, and requirements of the company's regulators, the cost and other effects of legal and administrative cases, changes in the creditworthiness of customers and the impairment of collectability of loans, fluctuations in market rates of interest, and other risks and factors identified in first merchants' filings with the Securities and Exchange Commission. First, merchants undertake 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. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star and then one. To withdraw your question, you may press star and two. Please also note today's event is being recorded. And at this time, I'd like to turn the conference call over to Mr. Mike Rechin, President and CEO. Sir, please go ahead.

Thank you, Jamie, and good afternoon, everyone. Welcome to our earnings conference call and webcast for the second quarter ending June 30th, 2020. Joining me today for presentation are Mark Hardwick, our Chief Financial Officer and Chief Operating Officer, John Martin, our Chief Credit Officer, and Michele Kawiecki, our Senior Vice President and Director of Finance. 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 are also contained at the back of the release, and my comments begin on page four, a slide titled Second Quarter 2020 Highlights. So on that page up top, First Merchants reported net income of $33 million for the quarter, or earnings per share of 62 cents. Earnings compared at 41.1 million during the same period in 2019. Whereas the $0.62 in second quarter earnings compared to $0.83 earned in the second quarter of 2019. Produced a return on assets of 97 basis points. Considered in a related context, the earnings provide pre-tax provision ROA of 1.73% or pre-tax provision return on equity of 13.18%. Balance sheet grew, total assets grew to $13.8 billion, $3.1 billion or 28.7% over the second quarter of 2019. And as Mark will highlight later, it was a combination of our September 1st, 2019 closing of Monroe Bank and Trust, organic growth through the period, and then as the sub-pull-it point says, total loans were helped by approximately $900 million of PPP volume in a program that set up very well for our client base. John will be on, obviously, to talk about asset quality, but in consideration of our second quarter provision, our allowance and fair value marks totaled 1.62% of loans. Michele is going to provide additional comments as well. In her remarks... I'm down in the deposit section, a meaningful part of the margin equation. I feel like we make great progress in the quarter. Deposit volumes up as Mark's going to detail. Steady progress in cost reductions. In fact, our 47 basis point cost for the second quarter down 50 basis points from year end's number of 97 basis points. As you look at the detail in our deposit mix, You'll see a close review will show that our deposit structure has management anticipating additional interest rate in dollars and expense savings linked to our remaining and laddered CD volumes and maturities. Capital levels stay very high, TCE to assets of 9.31%, and as the press release notes, that without PPP loans, our TCE level is actually 9.93%. A $23.04 book value per share grows 9.7% increase over the second quarter last year and a similar compounded growth rate over time. Moving to page five. Very busy second quarter as a provider of all elements of the CARES Act, most notably PPP. I alluded to it a moment ago. More than 5,000 applications really readily received both by our bankers and by the marketplace. I think I saw an article this week that said we produced the third most PPP loans in the entire state of Indiana of all banks. John Martin and our banker team recently negotiated with an outside partner that will be helping us through the forgiveness process, the forgiveness phase, using our own folks along with a partner as we continue to understand what will be the preparedness by the SBA to take the forgiveness applications. We're also a registered Main Street lender, and we're assessing the fits of that program as it evolves. The listeners might know that there's new features announced weekly for that, and we look forward to seeing if that's a good fit for any of the clients in our marketplace. A lot of big impacts coming up out of the resolution of the loan modifications. And so John remarks go deep into that. $1.25 billion in modifications, approximately 12% of the portfolio. When I use the term robust process in the middle bullet point, what I'm really talking about is direct client dialogue. Working with interim financials, CFO forecasts, business owner views of their need for additional help. and as the last bullet point says, really a modest amount, if none, by the end of the second quarter and I think a trickle of them that John will speak to about second requests on the back of the help that we provided through the second quarter. The balance sheet loaded with liquidity with a loan-to-deposit ratio just under 85%. had deposit growth from all sources, liquidity of our consumer and commercial clients held at first merchants to include some of the PPP balances. And then, as Mark will highlight, some really strong cash balances that we're looking for the highest yield that we can possibly attain in this period of really significant liquidity. I'm going to go to page six. Not efforts over the last five months, really, throughout the bullet points here. Making sure that anyone that's doing business with us or doing business on our behalf, our employees, feel safe. And so while all of the banking centers were open by July the 1st, we're doing it away through modifications and protective barriers that are welcoming to our clients. and put our bankers in a position to be the best banker that they can be. That environment would include required masks and this is even ahead of some of the governors that have done that but just a feeling on our part that it makes for a better environment to continue to be the advisor that our clients expect. I think we touched on at our last call some of the enhancements we made to capacity levels so that bankers that were more accustomed to using face-to-face banking in lobbies to the extent that they couldn't, they still had mobile and online limits materially higher as well as a lot of one-on-one coaching for those folks that hadn't been digital bank users in the past to take advantage of our investments over the last several years. Towards the bottom, a bullet point that calls return to office. It's an HR-driven framework. that we use that flexes to the environment. All parts of the country have kind of had fits and starts and it allows us to react to our company experience specifically and the government pronouncements as they come about. We have a fully armed pandemic team that digests information and then communicates it out to the rest of the company. Bottom of the page, the community support. The efforts listed here have really served as a rallying point for our colleagues through this difficult period of time. Top bullet point, we had a commitment of a million dollars in donations distributed to not-for-profits. I think Mike Stewart, our Chief Banking Officer, quarterbacked that effort. It included our regional presidents, obviously. I think we were able to get funds to over 200 frontline organizations. and so that investment, I'll call it, call it an expense, reflects itself in our second quarter marketing expense which you might have noticed. We captioned it internally as the right thing to do. Bottom bullet point talks about an announcement we made that we're excited about. We've named our first ever Director of Corporate Social Responsibility and it links to the middle point. But the Director of Corporate Social Responsibility is really combining a lot of efforts that had existed heretofore with a little bit more muscle on them. It's an internal leader within our company, previously the market president of our monthly market, which is a headquarters market. Scott McKee it is by name. He's going to lead several prior efforts as one larger, more impactful effort. With the region presidents, Scott's going to lead the community benefit agreement execution among all of his responsibilities, and that's the middle point on the page. A five-year, $1.4 billion agreement that we announced in conjunction with the NCRC, but really with community groups throughout the larger markets within the markets that First Merchants serves. and what it references credit on here, it really is going to be directed towards low and moderate income needs in mortgages, small business, affordable housing and then on top of those credit related answers and solutions to the needs of our communities, philanthropy and banking center access. So we're excited about it. Page 7, just a snapshot that might give you some context for some of the answers or material provided by either Mark, Michele, or John throughout the balance of our call today. It's a map of our franchise. Again, page 7. Tried to just show you some of the progress that's been made. And prior to hearing from Mark, just a summarizing look at our marketplaces. You know, the Midwest... In our view, it's on the early end of reopening, and so you see some of the improvement in unemployment. There are no guarantees from me as to where we go from here, yet there are no notable COVID hotspots on a full country basis that exist in the Midwest or in our franchise. And so we're just working our way at it, week at a time, trying to take advantage of the situation. And as you can see by the unemployment numbers, the workers are finding opportunities, which ought to give rise to a healthy First Merchants and a healthy Midwest. Paying close attention to what the governors of those states have to say. So as we try and move forward, we're doing it in a really balanced way. And at this point, I'm going to turn it over to Mark so we can get a little bit deeper into the results themselves.

Thanks, Mike. Yeah, I have a real sense of pride around those community support comments you just made. And I'm excited about our ability to just enhance the financial wellness of the diverse communities we serve. So those initiatives are exciting and important. If you turn to slide 9, total assets on line 7 increased by $1.4 billion or 21.9% annualized since year-end 2019. Our investments on line 1 increased by $193 million or an annualized 15% following up a strong 2019 where investments increased by 59% over 2018. providing really strong liquidity for the company. Loans on line two have increased by $831 million since year end. Of that increase, the PPP loans accounted for $883 million net of deferred fees and costs. Additionally, on line three, the allowance for loan loss has increased by $41 million or 51% year to date, primarily due to COVID-19. related economic challenges. The composition of our $9.3 billion loan portfolio shown on the upper right side of slide 10 produced a second quarter 2020 yield of 4.10%, down from the first quarter of 2020 yield of 4.85%. An 83 basis point decline in LIBOR during the quarter was the primary driver of the decrease in loan yields and PPP loans accounted for about six basis points of the decline. On slide 11, our investment portfolio has a longer duration than our peer group, which is a nice offset to the variable rate loan portfolio that we have. And as of June 30th of 2020, our unrealized gain totaled $139.1 million. Our yields are stable, totaling 3.02%, with remaining maturities in 2020 totaling $253 million, with an average yield of 2.56%. And 2021 maturities total $429 million, with a yield of 2.25%. On slide 12, total deposits increased by $1.1 billion or 22.9% annualized over year-end 2019. Obviously, some portion of the increase is due to PPP loans that have remained on deposit, which we estimate to be about one-half of the 2020 growth that we've experienced. We believe that our loan-to-deposit ratio of 85% and our loan-to-asset ratio of 67% again provides the bank with strong liquidity levels. The mix of our deposits on slide 13 is the key to both liquidity strength and low-cost funding. Second quarter interest expense on deposits totaled 47 basis points down from the first quarter of 2020 of 88 basis points. This reduction of 41 basis points helped us offset what was an unusually challenging decline in loan yields during the quarter. As we move through the remainder of 2020 and into 2021, we have time deposit maturities that should bring down interest expense even further. In the remainder of just 2020, we have nearly $900 million of CDs that will mature with an average rate of 1.77%. And we're anticipating about 140 basis points of savings as those CDs mature throughout the rest of this year. All regulatory capital ratios on slide 14 are well above the regulatory definition of well capitalized and are internal targets which ensures the bank maintains strong levels of capital. When adjusted for PPP loans, which are 100% government guaranteed, our tangible common equity ratio would recalculate to be 9.93% as you can see on the slide and as Mike previously mentioned. Now let's turn to slide 15, the corporation's net interest margin, net of fair value declined by an additional 27 basis points from the first quarter of 2020 to the second quarter of 2020. Of the decline, PPP loans accounted for six basis points. As mentioned during the discussion about loans and deposits, our loan yields declined more than expected as a result of LIBOR rate reductions. Our guidance only called for a ten basis point decline as this rapidly changing environment impacted the quarter at the highest end of our modeling. During last quarter, we were anticipating the lower end of the range. Much of our confidence was due to the aggressive deposit rate reductions deployed by our team. However, it simply wasn't enough to outrun the rapid repricing and earning assets that we experienced. From this point forward, PPP fee amortization should be the primary point of discussion. Although we don't know how quickly the SBA will process the forgiveness of PPP loans, we have clients that are eager to move forward. for 80% of the PPP loans to be forgiven evenly over the next 12 months, although that's just an estimate. This acceleration of fee income should allow net interest income and margins to increase on a reported basis, but the core net interest margin excluding fair value and PPP should remain stable. Non-interest income on slide 16 totaled $26.5 million for the second quarter of 2020. The decline in fee income from the first quarter totaled $3.3 million and fees from customers accounted for $2.5 million of the decline. Service charges on deposits on Line 1 was the primary driver, accounting for $1.7 million of the decrease as customer average balances increased, resolving in just half of our normal NSF and OD fees for the quarter. May was a low point for service charge income, but we did see a nice recovery in June. Wealth management fee income is down $384,000, and more than half of the decline is related to tax prep work that is directly offset in other expense. Card payment fees increased by $190,000 during the quarter. Gains on the sale of mortgage loans continues to be a bright spot and our performance as they increased by $311,000 for the quarter and hedge income was down for the second quarter compared to the first quarter as loan closings excluding PPP loans is less than our normal run rate. Non-interest expense on slide 17 totaled just $60 million in the second quarter of 2020 compared to $66.1 million in the first quarter. The decline was driven by $2.3 million of deferred salary expense related to PPP, a $1.1 million reduction in bonus accruals, and a $1.6 million decrease in debit card payment processing expense due to the termination of a rewards program. We also expensed nearly $1 million in the quarter based on our contribution levels that we committed to for COVID relief. We anticipate non-interest expense in the third quarter of 2020 to be closer to $64 million. Now on slide 18, we were pleased that our bottom line totaled $33 million in net income and earnings per share totaled 62 cents. We also like the strength of our pre-tax, pre-provision return on assets. of 1.73% and an efficiency ratio of less than 48% per quarter. On slide 19, you can see trends of EPS, dividends, and tangible book value per share, and we chose to add a dividend payout ratio line as well. We believe that our dividend, which is still less than a 50% payout, is reasonable in this environment. And on slide 20, You'll notice our total compound annual growth rate of tangible common equity is still 10.13%, 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 loan loss coverage and capital strength.