First Merchants Corporation

and welcome to the First Merchants Third Quarter 2020 Earnings Conference Call. All participants will be in 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 touch-tone phone. To withdraw your question, please press star, then two. This presentation contains forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Legislation Reform Act, such forward-looking statements can be identified by the use of the word believe, expect, or may, and include statements relating to First Merchant's business plan, growth strategies, loan and investment portfolio, asset quality, risks, and future costs. The 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, legislation changes in the creditworthiness of customers, fluctuations in market rates of interest and other risks and factors identified in First Merchants filing with the Securities and Exchange Commission. First Merchants undertakes no obligation to update any forward-looking statement, whether written or oral, related to the matters discussed in this presentation or press release. In addition, the company's past results of operation do not necessarily indicate its anticipated future results. Please note this event is being recorded. I would now like to turn the conference over to Mike Reckin, President and CEO. Please go ahead.

Thank you, Emily. And welcome, everyone, to our earnings conference call and webcast for the third quarter ending September 30th, 2020. I am joined this afternoon by several of our executives. Specifically, Mark Hardwick, our Chief Financial Officer, Chief Operating Officer, and soon to be Chief Executive Officer, as well as John Martin, our Chief Credit Officer. Also joining us today is Michelle Kaviesky, our Director of Finance and soon to be Chief Financial Officer, effective January 1st. Mike Stewart. Our chief banking officer and soon to be president of this company also with us in the event that he can add thoughts or that may come out through questions later in the presentation. Given the unusual year and rapidly changing environment, our goal is to provide a thorough review of our third quarter's results coupled with an eye towards 2021 as our planning matures, looking for our opportunity next year. 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 the release, and my next thoughts will start from page four, a slide titled Third Quarter 2020 Highlights. First Merchants has reported third quarter 2020 net income of $36.2 million compared to the $36.8 million during the same period in 2019. Earnings per share for the period totaled 67 cents per share compared to the third quarter of 2019 result of 71 cents per share. Also at the top of slide four, is referenced to our pre-tax pre-provision income of $54.4 million and a resultant 1.59% return on assets. The quarter featured a stabilization of our core net interest margin that Mark will speak to here shortly, as well as strength in our fee categories, specifically those client-related fee categories that reflect increased activity. Mark will be speaking to all the components of our non-interest income, including our first incurrence of Durbin Amendment limitation. Middle of the page, asset and deposit comparatives, primarily with last year's third quarter, and the growth in each primarily reflected due to the PPP program earlier in 2020. The quarter had a low level, an absence of organic growth in the loan generation, despite active origination levels that I know are part of John Martin's comments, and I'm happy to speak to our pipeline as we look forward, maybe at the back end of the conversation. Bottom of page four, a couple of metrics around the growth and high level of our capital levels, including tangible book value per share growth in this middle bullet point. 10.4% over the third quarter of 2019, and added at the bottom of the capital section a comment that would complement some of the material that John will detail later, and that is Moody's providing a bank standalone assessment of our credit at an A3 baseline. I'm going to move to page five, some additional asset quality comments. including our measure of allowance and fair value marks at 1.65% of loans, reserve build throughout the period in anticipation of additional recessionary environment moving into next year, a $12.5 million provision in the quarter, mildly down, and yet several million dollars, $6 million above our net charge off responsible for the reserve build. liquidity, even more evidence of a healthy balance sheet, and alluding to the $3.4 billion investment portfolio that continues to have top quartile industry performance. John's going to speak in his material about the state of our CARES Act, reaction to the marketplace and our clients' needs, and the materially low level of remaining portfolio in deferral, including he'll get into the concentrations within those deferrals and speak to really the only meaningful concentration at all in the hospitality business. The metrics around the CARES Act behavior at the bottom of page five, specifically the reference to $900 million in funded originations in the PPP program, the applications effectively match what we would have discussed at the June 30 call, although at this point, and John may cover it, we're well into the filing of applications for forgiveness and look forward for that to accelerate through the balance of this year and certainly through the first part of 2021. I move to page six and reference a franchise map that we used in our last call. And we're seeing progress and recovery throughout the markets we're in. You can see some of the comparative levels of unemployment around the states that we do business in. Consistent with national numbers, the COVID cases rising, and yet our markets remain predominantly open. It's allowed our bankers to be when consistent with customer preference, on the street, seeing our clients, or through whatever communication medium is called for. But the activity, based on the relative geographic openness of our economies, have been terrific for us to resuscitate the economies. At this point, even with the rising cases, we've had very limited government-mandated retrenchment on any of the openness stages that our primary markets have had, specifically Ohio and Indiana that house 85% roughly of our loans and greater than 80% of our deposits. So at this point, I'm going to let Mark and John and Michelle speak a little bit deeper into the results for the quarter.

Thanks, Mike. My comments will begin on slide eight, where total assets on line seven increased by $1.3 billion. or 13.7% annualized since year end 2019. Investments on line one increased by $337 million or an annualized 17.3% following a strong 2019 where investments increased by 59% over 2018. Loans on line two have increased $779 million since year end Of the increase, PPP loans, net of deferred loan fees and costs accounted for $901 million of the growth. And you can see that number highlighted in footnote one. Additionally, on line three, the allowance for loan losses increased by $47 million, or 59% 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-hand side of slide 9 produced a third quarter 2020 yield of 3.93%, down from the second quarter of 2020 yield of 4.10%. Despite the linked quarterly decline in overall loan yields of 17 basis points, our net interest margin, which I'll speak to in a moment, stabilized materially this quarter. also of note ppp loans negatively impacted loan yields by 12 basis points this quarter and nine basis points in in the second quarter of 2020. so our normalized loan yield for the quarter was 405 versus the 393. on slide 10 as of september 30 2020 our 2.9 billion dollar investment portfolio produced a 2.94% yield with an unrealized gain of $141.5 million. We anticipate expanding our commitment to the tax exempt municipal sector, which currently stands at 56% of the portfolio. Our quarterly gains highlighted on the right side of the page are a result of opportunistic sector migration and duration management. This active management along with the sector allocation decisions are the reason that our yields are about 70 basis points better than our peer group, and our unrealized gain is nearly double the peer group. On slide 11, total deposits increased by 1.1 billion, or 14.4% annualized over the year in 2019, following 2019 growth of 2.1 billion, or nearly 27%. Some portion of the increase is due to PPP loans and their related deposit balances. We believe that our loan-to-deposit ratio of 85% and our loan-to-asset ratio of 67% provides the bank with strong liquidity levels. The mix of our deposits on slide 12 are key to both liquidity strength and low-cost funding. Third quarter interest expense on deposits totaled 36 basis points, down from the second quarter of 2020, total of 47 basis points. The reduction of 11 basis points helped offset the loan yield compression that I mentioned on Slide 9. As we move through the remainder of 2020 and into 2021, we have deposits repricing that should bring down our interest expense even further. In the remainder of just 2020, we have another 348 million of CDs that mature with an average rate of 1.67%. Given a new rate of approximately 30 basis points or less, our savings should be approximately $1.2 million per quarter. All regulatory capital ratios on slide 13 are above the regulatory definition of well-capitalized. and our internal targets, which ensures the bank maintains strong capital for events such as the current cycle we're in. When adjusted for PPP loans, which are 100% government guaranteed, our tangible common equity ratio increased during the quarter to 10.19%. Now let's turn to slide 14. The corporation's net interest margin decreased four basis points. and just two basis points net of fair value accretion from the second quarter of 2020 to the third quarter of 2020. Of the decline, PPP loans accounted for one basis point because PPP loans caused margin to decline by seven basis points this quarter compared to six basis points last quarter. So just stated differently, we're down four basis points, two basis points of the decline, are related to fair value accretion decreases and another basis point is related to all the PPP loans that we have on the books at the end of the quarter. We believe net interest margin has reached a predictable level for the near future and should carry us into 2021. Line 1 of this slide is also encouraging as net interest income on a fully taxable equivalent basis increased by a couple hundred thousand dollars over the second quarter of 2020, now totaling $97.3 million. Non-interest income on slide 15 totaled $26.1 million for the third quarter of 2020. Customer-related fees increased to $23 million, up from just $21.1 million in the second quarter of 2020, despite a $2 million decline in card payment fees on Line 3 as the Durham impact was fully realized in the quarter. The gradual return of service charges on deposits on Line 1 improved wealth management fees on Line 2, and the gains on sale of mortgage loans drove the improvement. from 23 to 21 net of the Durban impact. Service charges on line one include return check and OD fees, which declined in the second quarter of 2020 from the first quarter of 2020 by 1.7 million. In Q3, we recovered approximately 700,000 of our normal run rate. As the economy continues to improve, we anticipate regaining the remaining $1 million. As expected, non-interest expense on slide 16 totaled $64.7 million in Q3 of 2020. As a reminder, in Q2, we deferred $2.3 million in salary expense related to PPP loans. We had a $1.1 million reduction in our bonus accruals in Q2. And we had a $1.6 million decrease in debit card payment processing expense due to the termination of a rewards program. All these items lowered non-interest expense in the second quarter from normalized levels. We anticipate non-interest expense in the fourth quarter of 2020 to be in a very similar range as our third quarter 2020 results. Now on slide 17, we are pleased that our bottom line totaled $36.2 million in net income and earnings per share reached $0.67 per share. On slide 18, you can see trends in earnings per share, dividends, and tangible book value per share. And we believe that our dividend, which is still less than a 50% payout ratio, is reasonable in this environment. On slide 19, you will notice our total compound annual growth rate of tangible common equity is still over 10%, and our dividend yield is nearly 4.5%. Now, Michelle Kaviesky, Senior Vice President of Finance, will cover a couple of key items related to loan loss coverage and capital strength.