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spk16: Good day, and thank you for standing by. Welcome to First Merchants Corporation, second quarter 2023 earnings. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask the question during the session, you will need to press star 11 on your telephone. You will then hear a message advising that your hand is raised. To withdraw the question, simply press star 11 again. Be advised. that today's conference is being recorded. 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 risk 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. The press release available on the website contains financial and other quantitative information to be discussed today, as well as reconciliation of GAAP to non-GAAP measures. I would now like to hand the conference over to the Chief Executive Officer, Mark Hardwick. Please proceed.
spk05: Well, good morning and welcome to the first March and second quarter 2023 conference call. Carmen, thank you for the introduction and for covering the forward-looking statement on page two. We released our earnings today at approximately 8 a.m. Eastern, and you can access today's slides by following the link on the second page of our earnings release or by going to our website through the investor relations section. On page three, you will see today's presenters and our bios to include President Mike Stewart, Chief Credit Officer John Martin, and Chief Financial Officer Michelle Kaviesky. On page four, you will see a map representing the geographic locations of our 119 banking centers, as well as a few financial highlights as of 6-30, June 30 of 2023. Turning to slide five, I'm happy to report that our performance remains healthy and strong and our teams continue to meet the demands of our communities and our client base. We reported second quarter 2023 earnings per share of $1.02 compared to 63 cents per share in the second quarter of 2022. or $1.01 when adjusted for a couple of extraordinary items last year to include our acquisition of Level 1. Net income was just over $60 million for the quarter. Our return on tangible common equity totaled 18.04% and return on assets totaled 1.34% for the quarter. Year-to-date, we've earned $124 million, or $2.09 per share. We remain committed to mid-single-digit loan growth and our continued low 50s efficiency ratio through the remainder of 2023 as we manage through what's left of continued modest margin compression. Now, Mike Stewart will provide more insight on our balance sheet to include a small non-core loan sale, and Michelle and John will cover their respective areas. We did see an uptick in non-accruals that I know John will be covering in detail.
spk13: Mike? Yeah, thank you, Mark, and good morning to all. Slide six remains unchanged and is a reminder that our financial results represent the durability of our business model within these markets we serve. And if you visualize the map on slide four, we primarily operate within these three states, the heart of the Midwest. Our markets include growing metropolitan cities like Indianapolis, Columbus, and Detroit, with many mid-sized cities and communities in between. As the last bullet point under the consumer banking header states, we serve diverse locations in stable rural metro markets. First Merchants has a granular and diverse customer base of deposits and loans derived from these four listed banking segments. Through the second quarter of 2023, these markets have remained resilient to the broad economic environment with stable unemployment rates and with businesses continuing to seek ways to expand and optimize their operations. We remain committed to our business strategy, and we remain committed to our strategic direction of organic growth. continuing to invest in our team, continuing to invest in our technology platforms and top tier financial metrics. So if we turn to page seven, the top of the page offers a breakdown of our core loan growth by business units. The total annualized loan growth for the second quarter was 1.5% and 4.7% for the first six months of 2023. As noted on the page, we chose to sell a $116 million commercial loan portfolio that was not core to our relationship banking expectations, as there was no ability to cross-sell or gain depository balances from those clients. That portfolio had been aggregated over the years through bank acquisitions and through direct origination. The portfolio was managed centrally and had a secondary market valuation that allowed for an effective sell. So, as the footnote states, when adjusting for that $116 million sell, our annualized second quarter loan growth was 4.7% and 6.9% for the first six months of 2023. Moreover, when adjusting for the sell, the commercial segment loan growth for the quarter was 4.1% versus the 0.9% decline on the top right-hand side of the slide. All the commercial loan growth during the quarter was within the commercial industrial sector, as our investment real estate portfolio showed a small decline. The commercial segment, as we've talked about before, represents over 75% of our total loan portfolio, and the new loan generation during the quarter was approximately $142 million when adjusting for that non-relationship loan sale, and over $300 million year-to-date. While the consumer segment on this page contracted this quarter by 0.6%, that dollar amount was less than $2 million. And all that decline was within our private banking clientele. The mortgage portfolio growth during the quarter was approximately $80 million in adjustable rate loans. And as we discussed last quarter, we have modified our mortgage approach and have pivoted back to an originating sell model with a target of 70% of originations to be sold. Page 15, the non-interest income highlights page, reflects that continued growth in gain on self-fee income. So overall, the commercial segment continues to be the loan growth engine of the bank, and we continue to get higher spreads on our new loan generation. Within investment real estate segment, the spreads continue to widen up to 50 basis points on a similar risk profile from the second half of 2022. And within the CNI space, the spreads have widened up to 25 basis points with a strong emphasis on relationship strategies, deposits, and fees. The commercial and consumer loan pipelines ended the quarter at consistent levels to prior quarters. So like I said before, we are committed to continued organic loan growth with our clients and with prospective clients. Our balance sheet is positioned for that growth and our underwriting remains consistent and disciplined across all of our markets. The overall economic environment coupled with our current loan pipelines affirms my expectation of single-digit loan growth moving forward through 2023 with commercial driving the bulk of that growth. Let me talk a little bit about deposits, which is the bottom half of that page. Deposit balance contracted roughly 3% on an annualized rate for the second quarter, but through the first six months of 2023, total deposits have grown nearly 3%. The commercial and consumer decline is primarily due to clients using their excess liquidity within their working capital cycles or their capital plans to minimize debt usage or to optimize their capital structures. These clients with the clients that have excess deposits have been active in taking advantage of money market and CD rates, specifically municipalities and private wealth clients. On a unit basis, we continued to grow our commercial and consumer households throughout the quarter and year-to-date. I'll turn the call over to Michelle to review more detail the composition of our balance sheet and the drivers of our income statement. Michelle.
spk18: Thanks, Mike. Slide 8 covers our second quarter results and that is followed by the year-to-date results on slide 9. As Mike touched on in his remarks, loan growth totaled $163.2 million this quarter, which was offset by the sale of $116.6 million of loans, which netted to our stated loan growth of $46.7 million for the quarter. The investment portfolio declined $165.9 million during the quarter, which included sales of bonds totaling $101 million. Despite a deposit decline of $122.1 million, we were able to reduce federal home loan bank advances by $100 million and kept broker deposits flat this quarter. All of this demonstrates good liquidity and balance sheet management while maintaining the ability to support our customers' credit needs despite the industry's liquidity tightening. Our loan-to-deposit ratio increased slightly to 84.3% this quarter compared to 83.3% in the prior quarter. Pre-tax pre-provision earnings totaled $71.6 million this quarter. Pre-tax pre-provision return on assets was 1.58%, and pre-tax pre-provision return on equity was a strong 13.38%, all of which reflects strong profitability metrics. Tangible book value per share totaled $23.34, an increase of 41 cents over prior quarter and $2.89 over the last year. Details of our investment portfolio are disclosed on slide 10. The sale of $101 million in bonds that I mentioned resulted in a realized loss of $1.4 million or 1.4%. The effective duration of the portfolio remains stable at 6.5 years. Expected cash flows from scheduled principal and interest payments and bond maturities through the remainder of 2023 totals $150 million. Since quarter end, we have sold approximately $35 million in bonds, and we will continue to sell bonds where we see opportunity creating additional cash flow. Slides 11 and 12 show some details of our loan portfolio and our allowance for credit losses. The total loan portfolio yield increased meaningfully, up 34 basis points to 6.34%. New and renewed loan yields averaged 7.3% for the quarter, an increase of 22 basis points from last quarter. New commercial loan yields are generally higher with yields in the high 7s and low 8s. Mortgage construction loans that were locked in a lower rate environment offset those higher commercial loan yields, impacting the overall new loan yield. 8.2 billion of loans or 67% of our portfolio are variable rate with 38% of the portfolio repricing in one month and 54% repricing in three months. So we will continue to benefit from loan repricing throughout the remainder of the year. The allowance for credit losses on slide 12 remains robust at 1.8% of total loans, along with $26.9 million in fair value accretion remaining. We did not book any provision expense this quarter, but will continue to monitor economic forecast changes, loan growth, and credit quality to determine provision needs in the future. Slide 13 shows details of our deposit portfolio. We continue to have a strong core deposit base with 43% of deposits yielding five basis points or less. The percentage of uninsured deposits declined to 25.5%, and the average deposit account balance is only 34,000, reflecting a diversified deposit franchise. Our non-interest-bearing deposits were 18% of total deposits at the end of the quarter, which was down from 20% in the prior quarter, reflecting the continued mix shift driven by our commercial customers. Although total deposits were down 122 million at quarter end, they have increased by 168 million since June 30th. Our total cost of deposits increased 58 basis points to 1.99% this quarter, reflecting the competitive pricing environment. Our interest bearing deposit cycle to date beta at quarter end was 47%, which was up from 37% last quarter. Note that our deposit betas do include time deposits. Although we expect the cost of deposits to continue to increase through the remainder of the year, we expect the pace will be slower than what we've experienced this quarter. Next, I will cover some notable income statement items, beginning with net interest income on slide 14. Net interest income on a fully tax-equivalent basis of $143.7 million declined $6.7 million from the prior quarter, but was $8.9 million higher than the second quarter of 2022. The decline in net interest income reflects the margin compression we're experiencing as the rising earning asset yield shown on Line 5 was offset with higher funding costs shown on Line 6. The resulting stated net interest margin on line seven totaled 3.39% for the quarter, a decline of 19 basis points. Despite the decline, we did see some stability in margin in the back half of the quarter, with June margin ending at 3.4%. Non-interest income on slide 15 increased 1.3 million, driven primarily by a 1.2 million increase in gains on the sale of mortgage loans. In previous quarters, we were portfolioing about 70% of mortgage production and selling 30%, but that has flipped and we are now selling 70% of the production and only portfolioing approximately 30%, so we will be able to sustain a higher level of mortgage sale gains going forward. Moving to slide 16, total expenses were in line with our guidance and totaled $92.6 million for the quarter. Salaries and benefits expense decreased 2.7 million compared to prior quarter due to lower incentives and an annual benefit plan expense that was recorded in Q1 of 1.3 million, thereby elevating Q1 expenses. FDIC assessment costs increased 1.3 million to a total of 2.7 million this quarter. We expect our FDIC assessment costs to normalize to a run rate of 3.1 million next quarter, given we have now recognized all of our FDIC assessment credits in the first half of the year. Our low core efficiency ratio is 52.21% for the quarter and 51.96% year to date, which is reflected in the top right of the slide, shows that we continue to achieve strong operating leverage despite rising funding costs and continued investments in our business. Slide 17 shows our capital ratios. Our strong earnings growth this quarter drove capital expansion in all ratios. The tangible common equity ratio increased 24 basis points, totaling 7.99% back to our internal target, despite the impact of increased unrealized loss valuation on the available-for-sale portfolio due to changes in rates during the quarter. The comments in the highlights communicate the strength of our capital ratios after reflecting the impact of unrealized losses in our bond portfolio. The common equity Tier 1 ratio for the quarter was 11.07%, and total risk-based capital ratio is now at 13.48%. Overall, we are pleased with our balance sheet strength and the sustainability of our business model as is reflected in our Q2 results. Our earning asset mix continues to trend in a favorable direction, and we feel our balance sheet is well positioned heading into the third quarter to support the growth of our company. That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John Martin, to discuss asset quality.
spk09: Thanks, Michelle, and good morning. My remarks start on slide 18. I'll highlight the loan portfolio, touch on the expanded portfolio insight slides, review asset quality and the non-performing asset role before turning the call back to Mark. So turning to slide 18 on line one, C&I, regional banking reflects the sale of the $116 million term loan B portfolio that Mike Stewart mentioned earlier. Backing this out, regional banking grew by $18 million, roughly 2.5% annualized. The decision to liquidate the term loan B portfolio was related to the non-relationship nature of these assets and the liquid nature of the portfolio. The entire portfolio was liquidated with a $128,000 gain. CNI sponsor finance grew $124 million driven by increased relationship management market coverage and slower than expected payoffs from sponsors who are being patient given the market. We have maintained consistent underwriting and continue to see stable to improved loan pricing. Moving down to slide nine, we slowed balance sheet growth of one to four family mortgage loans with $81 million added to the portfolio in the quarter. We've completed the origination transition strategy we discussed last quarter by adjusting loan rates to return to our historical levels. Turning to slide 19, I've included and updated the portfolio insights slide to provide additional transparency in the commercial space. The CNI classification includes sponsor finance as well as owner occupied CRE associated with the business. Our CNI portfolio is representative of our markets and has a 19% concentration in manufacturing. Our current line utilization remained consistent around 41% with commitments increasing $162 million. We participate in roughly $600 million of shared national credits across various industries down from $782 million last quarter associated with the term loan B sale just mentioned. These are generally relationships where we have taken a position and there is access to management and revenue opportunities beyond the credit exposure. We also have roughly 65 million dollars of SBA guaranteed loans in the sponsored finance portfolio. I continue to highlight key portfolio metrics. There are 80 relationships with 68% having a fixed charge coverage ratio of one and a half times. This is trended down with higher borrowing costs, but still healthy with a current classified loan portfolio of 3.8% as compared to 3.5% the prior quarter. Borrowers are platform companies owned by private equity firms with an eventual expectation of sale. We review the individual relationships quarterly for changes including leverage, cash flow, coverage, and borrower condition. Then moving to construction finance, we have limited exposure to residential development, and we are primarily focused on 1 to 4 family, non-track, individual-billed residential construction loans through our mortgage department. For commercial construction, we continue to have a bias towards multifamily construction. we've continued to give detail into our non-owner occupied commercial real estate portfolio since the great recession we have focused on multi-family cre lending while selectively adding projects and other segments office exposure is broken out the chart and represents 2.1% of total loans with the highest concentration outside of general office being in medical. From a historical perspective, the portfolio has performed well, much like the rest of the portfolio. The office portfolio is well diversified by tenant type and geographic mix. We continue to periodically review our larger office exposures and view the exposures as mitigated and acceptable given the current market conditions. On slide 21, I highlight our asset quality trends and current position. NPAs and 90 days, greater than 90 days past due loans increased 13 basis points this quarter. We had two larger commercial relationships, which moved to non-accrual totaling $26.6 million, accounting for much of the change. The first credit was what I would term asynchronous caused by a fraud that impacted our borrowers ability to repay while the second was driven by a pullback in industrial construction in a segment of the market in which the borrower focused. On line three, the $6.6 million decline in 90 days past due resulted from the resolution of two separate relationships immediately following the first quarter and were not related to the relationships I just mentioned. Classified loans remain stable at 2.09% of loans below historical and pre-pandemic levels. And finishing out the slide, we had net charge-offs of $1.9 million or six basis points for the quarter. Then moving on to slide 22, where I've again rolled forward the migration of non-performing loans, charge-offs, ORE, and 90As past due. For the quarter, we added non-accrual loans on line two of $33.2 million, including the new non-accruals I just mentioned, a reduction from payoffs or changes in accrual status of $8.3 million on line three, and a reduction from gross charge-offs of $2.3 million. Dropping down to line 11, 90 days past due decreased $6.6 million, which resulted in NPAs plus 90 days past due up $15.9 million for the quarter. I appreciate your attention, and I'll turn the call back over to Mark Hardwick.
spk05: Great. Thanks, John, Mike, and Michelle. You know, we hear from you, our investors, all the time that you value the level of transparency that we share and just appreciate the time to tell our story. If you turn to slide 23 and 24, we highlight our 10-year CAGRs for growth and returns. And on slide 25, we have a reminder of our vision, mission, and our team's statement, along with the strategic imperatives that guide our decision-making. We do appreciate your time and attention. And at this point, we're happy to take questions.
spk16: Thank you. And with that, as a reminder, Star 1-1 will get you in the queue.
spk15: One moment for our first question, please. All right. And in the line of Ben Gerlinger with HOP-D Group, please proceed.
spk06: Hey, good morning, everyone. Good morning, Ben.
spk07: I was curious if we could just touch base on deposits. It seems like across the bank space, the second quarter is probably the most amount of pain and then it's starting to alleviate in the back half. I was curious if you could give any clarity towards like the end of quarter, if not July deposit costs and how things have trended over the past, let's call it 60 days in terms of pricing.
spk18: Yeah, Ben, I can start off and give you some information. So our June interest-bearing deposit costs were 2.6%. So hopefully that gives you some color. We do expect that there will still be some pressure on deposit costs, but we do think it will slow from here on out. It already feels like it's slowing a bit and has kind of felt like that, particularly through the back half of the quarter.
spk07: Gotcha. That makes a lot of sense. And it seems like From a credit perspective, everything is fine. But loan growth itself is probably a little bit softer in the back half of the year. I was curious, just what are some of the puts and takes that your clients are saying or potential frustrations or why they might not be lending? Or is this entirely just you guys pulling back on a little bit on the reins to adhere to pristine credit?
spk13: Mike Stewart here. I'll try to give you a point of view on that. We've been very focused on our relationship, so we're very willing to continue to work with our clients. Our underwriting, like I've noted, hasn't changed. We talked about a non-core relationship sell, so that's really not a point of view around our willingness to continue to be active in capital formation of our clients and our prospective clients. We're continuing to make sure that as we think about relationship and pricing during this period of time, that we get a nice balance on that. So clients or prospective clients have to assure that they've got a capital structure, an income statement, a repayment capacity that not only can work through the inflationary pressures that might be in their business absent interest rate increases, but now they've got to make sure that they can cover the absolute increases in interest rates. So I think there's a combination of businesses really evaluating their capital structures and their real need to use loans and be really judicious with that use because they want to get the right return on those. Might require more equity on transactions if you're in investment real estate or if you're doing an acquisition. But our point of view is our underwriting standards and are willing to extend our balance sheet is the same. Gotcha.
spk07: That's helpful. Sorry, just to circle back on the cost of deposits real quick. Michelle, when you think about just the back half of the year, looking at your average balance sheet versus the 260 reference, it doesn't seem like that much of an uptick. So hopefully we are beyond the worst of it here. But when you think about the next six months or even 12 months, Do you think the biggest portion is just mix shift that drives it higher? Or do you think that there's potentially some people waiting for the, all right, we're at the top here with the Fed rate hikes. Let me get the best rate I possibly can and shop it. That could drive a little bit more cost. What I'm really getting at is, is CD pricing and the time deposit pricing at its peak? Or do you think that That could also be a factor outside of just mixed shift alone.
spk18: Yeah, it's a good question, given that the Fed is probably going to do another raise here. And, you know, some forecasts have them doing two. And so whether that drives CDs up a tick more or not, you know, I feel like we're getting to a peak. And I think, you know, there may be some customers that may be still looking for some rate. And I think the mixed shift will have a part of it, too. I think it might be a combination of all those things, but... I do feel like we're getting closer to a peak. We just think, like I said, that we feel like there could be just a bit more pressure through the end of the year. I don't think we're at the peak yet.
spk13: I also just give a point of view. The daily routines of our bankers working with clients, the pace of play, the conversations around deposit pricing and assuring that clients are maximizing their deposit pricing has also started to slow. So I think that the general bank environment and where we're at is kind of at a level where we're all within the same deposit pricing channel markers, and we might all be getting there.
spk07: Right. It feels that way, at least in commentary thus far this earnings period. So I appreciate the color and insights. Good luck on the latter half of the year.
spk05: Yeah, Ben, thank you. It does feel that we're kind of getting to the end of this process. And we were encouraged by June. I'd love to see the same kind of results in July and August, but at least for now, optimistic based on the second half of the quarter.
spk16: Thank you. One moment for our next question, please. And it comes from the line of Nathan Race with Piper Sandler. Please proceed. Yes.
spk14: Hi, everyone. Good morning. Question on just some of the deposit growth expectations going forward. I think Michelle indicated that deposits were up about 1%. Um, that's far in 3 Q, so the plan for funding future longer, just a combination of some of the securities portfolio cash flow coming off in future deposit growth. And also curious that there's, if you could maybe size up, of course, and security portfolios, maybe near par that could also be sold to support future loan growth.
spk18: Yeah, I do think that's the way we'll fund our loan growth. I think it will be a combination of deposit growth as well as cash flows from the securities portfolio. And, you know, we still think that we'll be able to continue to sell some securities. We do find opportunities where we get good pricing. You know, in Q1, we sold $200 million. In Q2, we sold $100 million. We've sold 35 so far this quarter. I'd say that within that range of Q1, Q2 would be a good expectation going forward.
spk14: Okay, great. And I think just given that the June margin was kind of ahead of the quarter coming out of June, is it possible to expect just the margin compressions flowing? Is that kind of what was alluded to in your prepared remarks? And if you could maybe size up kind of the future pressure that we can expect in 3Q and 4Q?
spk18: Sure. We do expect the decline in net interest margin to slow through the rest of the year. You know, using the forward curve, our models are suggesting that we could see potentially maybe another 10 basis points of margin compression through the end of the year. And that's assuming that we see just a bit higher deposit beta, cumulative interest-bearing deposit beta as well.
spk14: Okay, great. And then just on expenses, you know, it was very well controlled in the quarter. I think last quarter we were thinking to 95 to 96 in terms of the run rate going forward. Does that still hold for the 3Q and 4Q this year?
spk18: Yeah, I probably would reinforce the guidance that we gave last quarter of the 94 to 95 on the expense side on a quarterly basis for the remainder of the year.
spk14: Okay, great. And then if I could just ask one more on credit. It sounds like there was some fraud related in the especially finance company credit that moved to non-accrual in the quarter. Are there any charge-offs that we should be thinking about tied to that credit in 3Q? And just any other additional details on that credit in particular, I think?
spk09: Yeah, so the potential loss content of that loan, And that relationship has not been fully identified at this point. You know, we continue to review, you know, the, you know, what happened in this situation and establish our specific reserve against that. But, you know, into the next quarter, you know, what we saw in the first quarter, we'll probably see a little bit more in the third quarter related to that name. than we saw in the second quarter.
spk05: Yeah, it was interesting. We found out about the situation pretty late in the quarter, and we're still actively trying to establish where we stand. And given that it was a fraudulent situation, it takes a while to peel back all the layers. And so we're anticipating some loss in Q3, but at this point we don't have a number.
spk14: Okay, understood. And then just maybe more broadly on the reserve going forward, obviously you guys are operating from a well above average level coming out of the second quarter. Any thoughts on maybe kind of where that bottoms over the next few quarters or is there kind of an ACL level that you want to stay above relative to loans or MPLs or anything within that context?
spk18: Yeah, I don't think we have like a bright line threshold. I think we're just going to continue to monitor the changes in the economic scenarios and how that informs the model. along with balancing information on our loan growth. You know, right now we don't see any systemic credit deterioration, which is good. But then we'll also monitor the level of charge-offs that we have. And I just think we'll just have to take it quarter by quarter, take all of that into account to determine, you know, whether we decide to book any provision or not.
spk05: Yeah, and Michelle has answered this in the past, but, you know, we've talked about our KPIs, our key performance indicators, and we've gone back to look at prior quarters, and we tend to think of the reserve as staying at 150 or above, but, you know, you still have to get through all the CECL models and make sure that it works.
spk14: Right. Makes sense. Okay. That's all I had. Thank you for the color.
spk01: Okay.
spk16: One moment for our next question, please. And he comes from the line of Daniel Tamayo with Raymond James. Please proceed.
spk23: Hey, good morning. Good afternoon, I guess now, everyone. Thanks for taking my questions.
spk02: So most of my questions have been asked at this point, but I jumped on a little late, so I apologize if I missed this. But just on the fee income outlook, I'm curious if you had an idea for where that may go and if there was anything unusual in the quarter related to the wealth business that brought that number down a bit.
spk18: Yeah, I don't think that there was really anything unusual related to the wealth business. But I would say, like, our overall level of fee income, it was a little higher this quarter over last quarter. And I really think this quarter's fee income level is a good run rate. We had a few things. The mortgage gains definitely was a plus. But, yeah. And I think we'll be able to maintain that level of mortgage gains going forward. So I think this is a good run rate to use.
spk05: Just a little more color. We're so pleased that we've made that shift from using the portfolio to get back to where we have historically been, which is more of a fee-for-service model. And getting to 70% sales, 30% portfolio really does change the fee income dynamic of the income statement.
spk22: Got it. I appreciate that, Keller. That's all I had. Thank you. Thanks, Danny.
spk16: Thanks, Danny. Thank you. One moment for our next question, please.
spk15: All right. And it comes from the line of Terry McEvoy with Stephens, Inc.
spk16: Please proceed. Hi.
spk11: Good morning, everyone.
spk21: Hi, Terry. Hey, Terry.
spk11: First question, on page 20, how much of that $261 million office portfolio will mature over the next 6 to 12 months? And what are your thoughts on the impact of updated appraisals and overall higher interest rates on that portfolio and the possibility of either reserves or charge-offs having to be taken?
spk09: yeah so when i look at the office portfolio terry um you know the largest names or relationships in that portfolio have a primary tenant who is i'll call it relationship so it's kind of owner occupied ish but they occupy less than half so it's not um up you know an office building that is in a downtown metropolitan sort of Um, configuration, it's a suburban location where, um, you know, we've got a tenant that's occupied a higher portion of the total. So, um, the concern over maturity and, you know, reappraisal and a write down. as we've kind of gone through that portfolio, is relatively low. I don't have the actual, you know, what matures in the next year or so, but, you know, we've been through the portfolio last year and feel pretty good about, you know, what we see in there.
spk11: Thanks for that. And, Michelle, a question for you. Did the outflow of non-interest-bearing funds deposits. Did that slow throughout the second quarter? And if we get a 25 basis point rate hike, all things being equals, is that a positive or negative for the net interest margin?
spk18: So on the non-interest bearing, it did slow some in the second quarter. And in fact, even just looking at June's not interest-bearing, and even what we've seen so far through July, it has slowed as well, that remix. In fact, in July, we haven't really seen the remix change at all. So we could still see a bit of remix. I would expect that we would through the end of the year, but the theme, I think, of our call is that we're starting to see some slowness in that area, which is great. And I would say that on the second part of your question, you know, given that we have two-thirds of our loan portfolio repriced, typically when we see rates increase, and I think with the slowness of deposit rates increasing, I would think that will be a benefit to the margin.
spk11: Thanks, Michelle. And then one last quick one, the two new non-accrual loans, either of them shared national credits?
spk09: But were they shared national credits? No, neither of them were. Great.
spk10: Thanks for taking my questions. Have a good day.
spk21: Thank you, Jerry.
spk16: Thank you. One moment for our next question, please. And it comes from the line of Brian Martin with Jenny. Please proceed.
spk03: Hey, good morning. Good afternoon, everyone. Hi, Brian.
spk12: Hey, Brian.
spk03: Nate, just one follow-up, I guess, Michelle, on the margin, and that was the, you know, I guess if you look at, you know, the margin, you know, I guess dropping, kind of all your guidance, I guess my assumption is assumes another rate hike in there for, you know, for the next meeting here, but just as you think about the dollars of NII in the second half, I mean, it's your expectation with the growth outlook, and I joined late, so I didn't miss any comments on the loan growth outlook, but it's the expectation that sequentially you can grow the dollars of NII even if the margin is declining a bit here in the second half?
spk18: I think with the margin declining, I think that there could be a bit of compression in net interest income. that we would see. Really, what we model is the net interest margin and, you know, right now our models are telling us about a 10 basis point decline. And we'll see. I mean, there's a lot of assumptions that go into us determining all of that. And, you know, it's been a pretty challenge from quarter to quarter to try to determine where we think things are going to be. But that's what our assumptions are today.
spk03: Okay. Okay. Perfect. And then, you know, maybe just one for, I guess, on the credit side, you know, I know there was one question on the shared national credits, but, John, I guess just anything when you're looking out there today that, you know, I guess where you're focusing more attention on or just areas that maybe you have a bit more concern on. I mean, the shared national credits was one thought, but just, you know, anything else that we should be paying closer attention to on the credit side or you are, you know, as you kind of look at the numbers and everything holding up still really well here.
spk09: This is a good question, Brian. You know, it's interesting. I look at, you know, we look at the portfolio and different cuts each quarter, and there's nothing there from a macroeconomic perspective. Interest rates have impacted borrowers with higher borrowing costs. You know, we focus a lot, we spend a lot of time with the commercial construction portfolio and the commercial real estate and, you know, the investment real estate portfolio. And I think You know, so far, you know, borrowers have been able to adjust to the higher rates either through higher rents or just been able to absorb the increased interest costs. But that's really about the only thing I would say. You know, we, you know, have had the senior living portfolio, but that's pretty well at this point. You know, we've hashed through it and really – work that to a point where I feel pretty good about that as well now. So that's how I'd respond to that.
spk03: Got you. Okay. And if I missed it, maybe just the loan growth outlook or just the pipelines in general. I don't know if, Mike, if you Can you just run back through that just quickly or just high-level comments? If it's not, I can go back and listen to the transcript later.
spk13: No, I'll hit them again. The bulk of our long-growth through the balance of the year will be coming through the commercial portfolio. We target that at that mid-single-digit run rate. When you adjust for the portfolio sell that we did, the commercial segment grew a little bit over 4% annualized in this quarter. It's 5% year-to-date, a little over that. And the pipeline in commercial is really the same as the pipeline going into this quarter. So I really feel good that the commercial business and our willingness to continue to be a relationship bank and extend our balance sheet will continue to see the growth in that single-digit run rate.
spk05: Yeah, there is no absence of demand. We're clearly trying to make sure that in this environment we're providing gaining the entire relationship and that we're getting paid for the extension of credit. And so we're pretty optimistic about the communication we're having with customers. The relationships are still very strong. And just recognizing the environment has changed a little.
spk03: Yeah, that all makes sense. So, okay, well, I appreciate you guys taking the questions in that nice quarter, guys.
spk04: Yeah, thank you, Brian.
spk16: Thank you. One moment for our next question, please. And he comes from the line of Damon Del Monte with KBW. Please proceed.
spk20: Hey, everybody. Hope everybody's doing well today. Pretty much most of my questions have been asked and answered, but just looking for a little bit more color on the brokered CDs you guys put on. What's the average term of those as far as like the maturity dates?
spk18: They tend to be more on the shorter end of the curve.
spk20: So generally like less than a year?
spk18: Yeah, less than a year or two years.
spk20: Okay. And then just one kind of modeling question here. I think you guys noted you had a bully gain this quarter. Could you call out how much that was?
spk18: Yeah, it was actually just a couple of very small ones. And so I think it was under $800,000, a bully gain.
spk20: Okay, perfect. Okay, that's all that I had. Everything else was asked and answered. So thank you very much. Thanks, Damon.
spk16: Thank you. And this concludes the Q&A session. I would now like to turn the call over to Mark Rick for closing remarks.
spk05: Thank you, Carmen. Thanks, everyone, for your participation. As you can tell, it's an interesting time for net interest margin. We're kind of at an inflection point, and it's hard to give absolute guidance. But, you know, we just have looked back at our history, and the first quarter of 22, our margin was 303. It did increase all the way to 372 as rates were rising rapidly. And we were benefiting from a variable rate loan portfolio and our ability to lag deposit rates. And eventually that changed and we had to start paying more for deposits. And we were additionally aggressive after the Silicon Valley failure that occurred. And so You know, if we landed at 339 for the quarter, we've got a 340 June. It's hard for us to come out and say, hey, we think the next rate increase causes margin to go up because we know there's still some additional modest pressure on deposits. But really looking forward to getting through the quarter, having a Q3 net interest margin number that we think kind of establishes a run rate going forward. So, We appreciate your time, and I know as you're working through all the different models and forecasts, it's a key component. So look forward to talking to you next quarter, and we appreciate your investment in First Merchants. Thank you.
spk16: And with that, thank you all for participating. This concludes the conference, and you may now disconnect. Thank you. Music playing Thank you. Thank you. Thank you.
spk01: Thank you.
spk16: Good day and thank you for standing by. Welcome to First Merchants Corporation second quarter 2023 earnings. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask the question during the session, you will need to press star 11 on your telephone. You will then hear a message advising that your hand is raised. To withdraw the question, simply press star 11 again. Be advised that today's conference is being recorded. 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 risk 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. The press release available on the website contains financial and other quantitative information to be discussed today, as well as reconciliation of GAAP to non-GAAP measures. I would now like to hand the conference over to the Chief Executive Officer, Mark Hardwick. Please proceed.
spk05: Well, good morning and welcome to the first March and second quarter 2023 conference call. Carmen, thank you for the introduction and for covering the forward-looking statement on page two. We released our earnings today at approximately 8 a.m. Eastern. And you can access today's slides by following the link on the second page of our earnings release or by going to our website through the investor relations section.
spk16: Good day, and thank you for standing by. Welcome to First Merchants Corporation, second quarter 2023 earnings. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask the question during the session, you will need to press star 11 on your telephone. You will then hear a message advising that your hand is raised. To withdraw the question, simply press star 11 again. Be advised. that today's conference is being recorded. 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 risk 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 gap measures. The press release available on the website contains financial and other quantitative information to be discussed today, as well as reconciliation of gap to non-gap measures. I would now like to hand the conference over to the Chief Executive Officer, Mark Hardwick. Please proceed.
spk05: Well, good morning and welcome to the first March and second quarter 2023 conference call. Carmen, thank you for the introduction and for covering the forward-looking statement on page two. We released our earnings today at approximately 8 a.m. Eastern, and you can access today's slides by following the link on the second page of our earnings release or by going to our website through the investor relations section. On page three, you will see today's presenters and our bios to include President Mike Stewart, Chief Credit Officer John Martin, and Chief Financial Officer Michelle Kaviesky. On page four, you will see a map representing the geographic locations of our 119 banking centers, as well as a few financial highlights as of 6-30, June 30 of 2023. Turning to slide five, I'm happy to report that our performance remains healthy and strong and our teams continue to meet the demands of our communities and our client base. We reported second quarter 2023 earnings per share of $1.02 compared to 63 cents per share in the second quarter of 2022. or $1.01 when adjusted for a couple of extraordinary items last year to include our acquisition of Level 1. Net income was just over $60 million for the quarter. Our return on tangible common equity totaled 18.04% and return on assets totaled 1.34% for the quarter. Year-to-date, we've earned $124 million, or $2.09 per share. We remain committed to mid-single-digit loan growth and our continued low 50s efficiency ratio through the remainder of 2023 as we manage through what's left of continued modest margin compression. Now, Mike Stewart will provide more insight on our balance sheet to include a small non-core loan sale, and Michelle and John will cover their respective areas. We did see an uptick in non-accruals that I know John will be covering in detail.
spk13: Mike? Yeah, thank you, Mark, and good morning to all. Slide six remains unchanged and is a reminder that our financial results represent the durability of our business model within these markets we serve. And if you visualize the map on slide four, we primarily operate within these three states, the heart of the Midwest. Our markets include growing metropolitan cities like Indianapolis, Columbus, and Detroit, with many mid-sized cities and communities in between. As the last bullet point under the consumer banking header states, we serve diverse locations in stable rural metro markets. First Merchants has a granular and diverse customer base of deposits and loans derived from these four listed banking segments. Through the second quarter of 2023, these markets have remained resilient to the broad economic environment with stable unemployment rates and with businesses continuing to seek ways to expand and optimize their operations. We remain committed to our business strategy, and we remain committed to our strategic direction of organic growth. continuing to invest in our team, continuing to invest in our technology platforms and top tier financial metrics. So if we turn to page seven, the top of the page offers a breakdown of our core loan growth by business units. The total annualized loan growth for the second quarter was 1.5% and 4.7% for the first six months of 2023. As noted on the page, we chose to sell a $116 million commercial loan portfolio that was not core to our relationship banking expectations, as there was no ability to cross-sell or gain depository balances from those clients. That portfolio had been aggregated over the years through bank acquisitions and through direct origination. The portfolio was managed centrally and had a secondary market valuation that allowed for an effective sell. So, as the footnote states, when adjusting for that $116 million sell, our annualized second quarter loan growth was 4.7% and 6.9% for the first six months of 2023. Moreover, when adjusting for the sell, the commercial segment loan growth for the quarter was 4.1% versus the 0.9% decline on the top right-hand side of the slide. All the commercial loan growth during the quarter was within the commercial industrial sector, as our investment real estate portfolio showed a small decline. The commercial segment, as we've talked about before, represents over 75% of our total loan portfolio, and the new loan generation during the quarter was approximately $142 million when adjusting for that non-relationship loan sale, and over $300 million year-to-date. While the consumer segment on this page contracted this quarter by 0.6%, that dollar amount was less than $2 million. And all that decline was within our private banking clientele. The mortgage portfolio growth during the quarter was approximately $80 million in adjustable rate loans. And as we discussed last quarter, we have modified our mortgage approach and have pivoted back to an originating cell model with a target of 70% of originations to be sold. Page 15, the non-interest income highlights page, reflects that continued growth in gain on self-fee income. So overall, the commercial segment continues to be the loan growth engine of the bank, and we continue to get higher spreads on our new loan generation. Within investment real estate segment, the spreads continue to widen up to 50 basis points on a similar risk profile from the second half of 2022. And within the CNI space, the spreads have widened up to 25 basis points with a strong emphasis on relationship strategies, deposits, and fees. The commercial and consumer loan pipelines ended the quarter at consistent levels to prior quarters. So like I said before, we are committed to continued organic loan growth with our clients and with prospective clients. Our balance sheet is positioned for that growth and our underwriting remains consistent and disciplined across all of our markets. The overall economic environment coupled with our current loan pipelines affirms my expectation of single-digit loan growth moving forward through 2023 with commercial driving the bulk of that growth. Let me talk a little bit about deposits, which is the bottom half of that page. Deposit balance contracted roughly 3% on an annualized rate for the second quarter, but through the first six months of 2023, total deposits have grown nearly 3%. The commercial and consumer decline is primarily due to clients using their excess liquidity within their working capital cycles or their capital plans to minimize debt usage or to optimize their capital structures. These clients with the clients that have excess deposits have been active in taking advantage of money market and CD rates, specifically municipalities and private wealth clients. On a unit basis, we continue to grow our commercial and consumer households throughout the quarter and year-to-date. I'll turn the call over to Michelle to review more detail the composition of our balance sheet and the drivers of our income statement. Michelle.
spk18: Thanks, Mike. Slide 8 covers our second quarter results and that is followed by the year-to-date results on slide 9. As Mike touched on in his remarks, loan growth totaled $163.2 million this quarter, which was offset by the sale of $116.6 million of loans, which netted to our stated loan growth of $46.7 million for the quarter. The investment portfolio declined $165.9 million during the quarter, which included sales of bonds totaling $101 million. Despite a deposit decline of $122.1 million, we were able to reduce federal home loan bank advances by $100 million and kept broker deposits flat this quarter. All of this demonstrates good liquidity and balance sheet management while maintaining the ability to support our customers' credit needs despite the industry's liquidity tightening. Our loan-to-deposit ratio increased slightly to 84.3% this quarter compared to 83.3% in the prior quarter. Pre-tax pre-provision earnings totaled $71.6 million this quarter. Pre-tax pre-provision return on assets was 1.58%, and pre-tax pre-provision return on equity was a strong 13.38%, all of which reflects strong profitability metrics. Tangible book value per share totaled $23.34, an increase of 41 cents over prior quarter and $2.89 over the last year. Details of our investment portfolio are disclosed on slide 10. The sale of 101 million in bonds that I mentioned resulted in a realized loss of 1.4 million or 1.4%. The effective duration of the portfolio remains stable at 6.5 years. Expected cash flows from scheduled principal and interest payments and bond maturities through the remainder of 2023 totals $150 million. Since quarter end, we have sold approximately $35 million in bonds, and we will continue to sell bonds where we see opportunity creating additional cash flow. Slides 11 and 12 show some details of our loan portfolio and our allowance for credit losses. The total loan portfolio yield increased meaningfully, up 34 basis points to 6.34%. New and renewed loan yields averaged 7.3% for the quarter, an increase of 22 basis points from last quarter. New commercial loan yields are generally higher with yields in the high 7s and low 8s. Mortgage construction loans that were locked in a lower rate environment offset those higher commercial loan yields, impacting the overall new loan yield. 8.2 billion of loans or 67% of our portfolio are variable rate with 38% of the portfolio repricing in one month and 54% repricing in three months. So we will continue to benefit from loan repricing throughout the remainder of the year. The allowance for credit losses on slide 12 remains robust at 1.8% of total loans, along with $26.9 million of fair value accretion remaining. We did not book any provision expense this quarter, but will continue to monitor economic forecast changes, loan growth, and credit quality to determine provision needs in the future. Slide 13 shows details of our deposit portfolio. We continue to have a strong core deposit base with 43% of deposits yielding five basis points or less. The percentage of uninsured deposits declined to 25.5% and the average deposit account balance is only 34,000, reflecting a diversified deposit franchise. Our non-interest bearing deposits were 18% of total deposits at the end of the quarter, which was down from 20% in the prior quarter, reflecting the continued mix shift driven by our commercial customers. Although total deposits were down 122 million at quarter end, they have increased by 168 million since June 30th. Our total cost of deposits increased 58 basis points to 1.99% this quarter, reflecting the competitive pricing environment. Our interest bearing deposit cycle to date beta at quarter end was 47%, which was up from 37% last quarter. Note that our deposit betas do include time deposits. Although we expect the cost of deposits to continue to increase through the remainder of the year, we expect the pace will be slower than what we've experienced this quarter. Next, I will cover some notable income statement items beginning with net interest income on slide 14. Net interest income on a fully tax equivalent basis of $143.7 million declined $6.7 million from the prior quarter but was $8.9 million higher than the second quarter of 2022. The decline in net interest income reflects the margin compression we're experiencing as the rising earning asset yield shown on line five was offset with higher funding costs shown on line six. The resulting stated net interest margin on line seven totaled 3.39% for the quarter, a decline of 19 basis points. Despite the decline, we did see some stability in margin in the back half of the quarter, with June margin ending at 3.4%. Non-interest income on slide 15 increased $1.3 million, driven primarily by a $1.2 million increase in gains on the sale of mortgage loans. In previous quarters, we were portfolioing about 70% of mortgage production and selling 30%, but that has flipped and we are now selling 70% of the production and only portfolioing approximately 30%. So we will be able to sustain a higher level of mortgage sale gains going forward. Moving to slide 16, total expenses were in line with our guidance and totaled $92.6 million for the quarter. Salaries and benefits expense decreased 2.7 million compared to prior quarter due to lower incentives and an annual benefit plan expense that was recorded in Q1 of 1.3 million, thereby elevating Q1 expenses. FDIC assessment costs increased 1.3 million to a total of 2.7 million this quarter. We expect our FDIC assessment costs to normalize to a run rate of 3.1 million next quarter, given we have now recognized all of our FDIC assessment credits in the first half of the year. Our low core efficiency ratio is 52.21% for the quarter and 51.96% year to date, which is reflected in the top right of the slide, shows that we continue to achieve strong operating leverage despite rising funding costs and continued investments in our business. Slide 17 shows our capital ratios. Our strong earnings growth this quarter drove capital expansion in all ratios. The tangible common equity ratio increased 24 basis points, totaling 7.99% back to our internal target, despite the impact of increased unrealized loss valuation on the available-for-sale portfolio due to changes in rates during the quarter. The comments in the highlights communicate the strength of our capital ratios after reflecting the impact of unrealized losses in our bond portfolio. The common equity Tier 1 ratio for the quarter was 11.07%, and total risk-based capital ratio is now at 13.48%. Overall, we are pleased with our balance sheet strength and the sustainability of our business model as is reflected in our Q2 results. Our earning asset mix continues to trend in a favorable direction, and we feel our balance sheet is well-positioned heading into the third quarter to support the growth of our company. That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John Martin, to discuss asset quality.
spk09: Thanks, Michelle, and good morning. My remarks start on slide 18. I'll highlight the loan portfolio, touch on the expanded portfolio insight slides, review asset quality and the non-performing asset role before turning the call back to Mark. So turning to slide 18 on line one, C&I, regional banking reflects the sale of the $116 million term loan B portfolio that Mike Stewart mentioned earlier. Backing this out, regional banking grew by $18 million, roughly 2.5% annualized. The decision to liquidate the term loan B portfolio was related to the non-relationship nature of these assets and the liquid nature of the portfolio. The entire portfolio was liquidated with a $128,000 gain. CNI sponsor finance grew $124 million driven by increased relationship management market coverage and slower than expected payoffs from sponsors who are being patient given the market. We have maintained consistent underwriting and continue to see stable to improved loan pricing. Moving down to slide nine, we slowed balance sheet growth of one to four family mortgage loans with $81 million added to the portfolio in the quarter. We've completed the origination transition strategy we discussed last quarter by adjusting loan rates to return to our historical levels. Turning to slide 19, I've included and updated the portfolio insights slide to provide additional transparency in the commercial space. The CNI classification includes sponsor finance as well as owner occupied CRE associated with the business. Our CNI portfolio is representative of our markets and has a 19% concentration in manufacturing. Our current line utilization remained consistent around 41% with commitments increasing $162 million. We participate in roughly $600 million of shared national credits across various industries, down from $782 million last quarter associated with the term loan B sale just mentioned. These are generally relationships where we have taken a position and there is access to management and revenue opportunities beyond the credit exposure. We also have roughly 65 million dollars of SBA guaranteed loans in the sponsored finance portfolio. I continue to highlight key portfolio metrics. There are 80 relationships with 68% having a fixed charge coverage ratio of one and a half times. This is trended down with higher borrowing costs, but still healthy with a current classified loan portfolio of 3.8% as compared to 3.5% the prior quarter. Borrowers are platform companies owned by private equity firms with an eventual expectation of sale. We review the individual relationships quarterly for changes including leverage, cash flow, coverage, and borrower condition. Then moving to construction finance, we have limited exposure to residential development and we are primarily focused on 1 to 4 family non tract individual build residential construction loans through our mortgage department for commercial construction. We continue to have a bias towards multi family construction. We've continued to give detail into our non owner occupied commercial real estate portfolio since the great recession. We have focused on multifamily lending while selectively adding projects and other segments. Office exposure is broken out the chart and. represents 2.1% of total loans with the highest concentration outside of general office being in medical. From a historical perspective, the portfolio has performed well, much like the rest of the portfolio. The office portfolio is well diversified by tenant type and geographic mix. We continue to periodically review our larger office exposures and view the exposures as mitigated and acceptable given the current market conditions. On slide 21, I highlight our asset quality trends and current position. NPAs and 90 days, greater than 90 days past due loans increased 13 basis points this quarter. We had two larger commercial relationships, which moved to non-accrual totaling $26.6 million, accounting for much of the change. The first credit was what I would term asynchronous, caused by a fraud that impacted our borrowers' ability to repay, while the second was driven by a pullback in industrial construction in a segment of the market in which the borrower focused. On line three, the $6.6 million decline in 90 days past due resulted from the resolution of two separate relationships immediately following the first quarter and were not related to the relationships I just mentioned. Classified loans remain stable at 2.09% of loans below historical and pre-pandemic levels. And finishing out the slide, we had net charge-offs of $1.9 million or six basis points for the quarter. Then moving on to slide 22, where I've again rolled forward the migration of non-performing loans, charge-offs, ORE, and 90As past due. For the quarter, we added non-accrual loans on line two of $33.2 million, including the new non-accruals I just mentioned, a reduction from payoffs or changes in accrual status of $8.3 million on line three, and a reduction from gross charge-offs of $2.3 million. Dropping down to line 11, 90 days past due decreased $6.6 million, which resulted in NPAs plus 90 days past due up $15.9 million for the quarter. I appreciate your attention, and I'll now turn the call back over to Mark Hardwick.
spk05: Great. Thanks, John, Mike, and Michelle. You know, we hear from you, our investors, all the time that you value the level of transparency that we share and just appreciate the time to tell our story. If you turn to slide 23 and 24, we highlight our 10-year CAGRs for growth and returns. And on slide 25, we have a reminder of our vision, mission, and our team's statement, along with the strategic imperatives that guide our decision-making. We do appreciate your time and attention. And at this point, we're happy to take questions.
spk16: Thank you. And with that, as a reminder, Star 1-1 will get you in the queue. One moment for our first question, please.
spk15: All right. And in the line of Ben Gerlinger with HOP-D Group, please proceed.
spk06: Hey, good morning, everyone. Good morning, Ben.
spk07: I was curious if we could just touch base on deposits. It seems like across the bank space, the second quarter is probably the most amount of pain and then it's starting to alleviate in the back half. I was curious if you could give any clarity towards like the end of quarter, if not July deposit costs and how things have trended over the past, let's call it 60 days in terms of pricing.
spk18: Yeah, Ben, I can start off and give you some information. So our June interest-bearing deposit costs were 2.6%. So hopefully that gives you some color. We do expect that there will still be some pressure on deposit costs, but we do think it will slow from here on out. It already feels like it's slowing a bit and has kind of felt like that, particularly through the back half of the quarter.
spk07: Gotcha. That makes a lot of sense. And it seems like From a credit perspective, everything is fine. But loan growth itself is probably a little bit softer in the back half of the year. I was curious, just what are some of the puts and takes that your clients are saying or potential frustrations or why they might not be lending? Or is this entirely just you guys pulling back on a little bit on the reins to adhere to pristine credit?
spk13: Mike Stewart here. I'll try to give you a point of view on that. We've been very focused on our relationship, so we're very willing to continue to work with our clients. Our underwriting, like I've noted, hasn't changed. We talked about a non-court relationship sell, so that's really not a point of view around our willingness to continue to be active in capital formation of our clients and our prospective clients. We're continuing to make sure that as we think about relationship and pricing during this period of time, that we get a nice balance on that. So clients or prospective clients have to assure that they've got a capital structure, an income statement, a repayment capacity that not only can work through the inflationary pressures that might be in their business absent interest rate increases, but now they've got to make sure that they can cover the absolute increases in interest rates. So all, I think there's a combination of businesses really evaluating their capital structures and their real need to use loans and be really judicious with that use because they want to get the right return on those. Might require more equity on transactions if you're in investment real estate or if you're doing an acquisition. But our point of view is our underwriting standards and are willing to extend our balance sheet is the same.
spk07: Gotcha. That's helpful. Sorry, just to circle back on the cost of deposits real quick. Michelle, when you think about just the back half of the year, looking at your average balance sheet versus the 260 reference, it doesn't seem like it's that much of an uptick. So hopefully we are beyond the worst of it here but when you think about the next six months or even 12 months do you think the biggest portion is just mix shift that that drives the it higher or do you think that there's potentially some people waiting for the all right we're at the top here with the fed rate hikes let me get the best rate i possibly can and shop it that could could drive a little bit more cost like what i'm really getting is cd pricing and the time deposit pricing At its peak, or do you think that that could also be a factor outside of just mix shift alone?
spk18: Yeah, it's a good question, given that the Fed is probably going to do another raise here. And, you know, some forecasts have them doing two. And so whether that drives CDs up a tick more or not, you know, I feel like we're getting to a peak. And I think, you know, there may be some customers that may be still looking for some rate. And I think the mixed shift will have a part of it, too. I think it might be a combination of all those things. But I do feel like we're getting closer to a peak. Yeah. We just think, like I said, that we feel like there could be just a bit more pressure through the end of the year. I don't think we're at the peak yet.
spk13: I also just give a point about the daily routines of our bankers working with clients. The pace of play, the conversations around deposit pricing and assuring that clients are maximizing their deposit pricing has also started to slow. So I think that the general bank environment and where we're at is kind of at a level where we're all within the same deposit pricing channel markers, and we might all be getting there. Right.
spk07: It feels that way, at least in commentary thus far this earnings period. So I appreciate the color and insights. Good luck on the latter half of the year.
spk05: Yeah, Ben, thank you. It does feel that we're kind of getting to the end of this process. And we were encouraged by June. I'd love to see the same kind of results in July and August, but at least for now, optimistic based on the second half of the quarter.
spk16: Thank you. One moment for our next question, please. And it comes from the line of Nathan Race with Piper Sandler. Please proceed. Yes.
spk14: Hi, everyone. Good morning. Question on just some of the deposit growth expectations going forward. I think Michelle indicated that deposits were up about 1%. Um, thus far in 3 Q, so the plan for funding future longer, just a combination of some of the securities portfolio cash flow coming off in future deposit growth. And also curious that there's, if you could maybe size up, of course, in securities portfolios, maybe near par that could also be sold to support future loan growth.
spk18: Yeah, I do think that's the way we'll fund our loan growth. I think it will be a combination of deposit growth as well as cash flows from the securities portfolio. And, you know, we still think that we'll be able to continue to sell some securities. We do find opportunities where we get good pricing. You know, in Q1, we sold $200 million. In Q2, we sold $100 million. We've sold 35 so far this quarter. I'd say that within that range of Q1, Q2 would be a good expectation going forward.
spk14: Okay, great. And I think just given that the June margin was kind of ahead of the quarter coming out of June, is it possible to expect just the margin compressions flowing? Is that kind of what was alluded to in your prepared remarks? And if you could maybe size up kind of the future pressure that we can expect in 3Q and 4Q?
spk18: Sure. We do expect the decline in net interest margin to slow through the rest of the year. You know, using the forward curve, our models are suggesting that we could see potentially maybe another 10 basis points of margin compression through the end of the year. And that's assuming that we see just a bit higher deposit beta, cumulative interest bearing deposit beta as well.
spk14: Okay, great. And then just on expenses, you know, it was very well controlled in the quarter. I think last quarter we were thinking to 95 to 96 in terms of the run rate going forward. Does that still hold for the 3Q and 4Q this year?
spk18: Yeah, I probably would reinforce the guidance that we gave last quarter of the 94 to 95 on the expense side on a quarterly basis for the remainder of the year.
spk14: Okay, great. And then if I could just ask one more on credit. It sounds like there was some fraud related in the especially finance company credit that moved to non-accrual in the quarter. Are there any charge-offs that we should be thinking about tied to that credit in 3Q? And just any other additional details on that credit in particular, I think?
spk09: Yeah, so the potential loss content of that loan and that relationship has not been fully identified at this point. We continue to review what happened in this situation and establish our specific reserve against that. Into the next quarter, what we saw in the first quarter, we'll probably see a little bit more in the third quarter related to that name than we saw in the second quarter.
spk05: Yeah, it was interesting. We found out about the situation pretty late in the quarter, and we're still actively trying to establish where we stand. And given that it was a fraudulent situation, it takes a while to peel back all the layers. And so we're anticipating some loss in Q3, but at this point we don't have a number.
spk14: Okay, understood. And then just maybe more broadly on the reserve going forward, obviously you guys are operating from a well above average level coming out of the second quarter. Any thoughts on maybe kind of where that bottoms over the next few quarters or is there kind of an ACL level that you want to stay above? relative to loans or MPLs or anything within that context?
spk18: Yeah, I don't think we have like a bright line threshold. I think we're just going to continue to monitor, you know, the changes in the economic scenarios and how that informs the model, along with balancing information on our loan growth. You know, right now we don't see any systemic credit deterioration, which is good, but then we'll also monitor the level of charge-offs that we have. And I just think taking, we'll just have to take a quarter by quarter, take all of that into account to determine, you know, whether we decide to book any provision or not.
spk05: Yeah, understood. That's all I have to answer. I've answered this in the past, but, you know, we've talked about our KPIs, our key performance indicators, and we've gone back to look at prior quarters, and we tend to think of the reserve as staying at 150 or above, but, you know, you still have to get through all the CECL models and make sure that it works
spk14: Right, makes sense. Okay, that's all I had. Thank you for the color.
spk16: One moment for our next question, please. And it comes from the line of Daniel Tamayo with Raymond James.
spk15: Please proceed.
spk23: Hey, good morning. Good afternoon, I guess now, everyone. Thanks for taking my question.
spk02: So most of my questions have been asked at this point, but I jumped on a little late, so I apologize if I missed this, but just on the fee income outlook, I'm curious if you had an idea for where that may go and if there was anything unusual in the quarter related to the wealth business that brought that number down a bit.
spk18: Yeah, I don't think that there was really anything unusual related to the wealth business, but I would say like our overall level of fee income, it was a little higher this quarter over last quarter, and I really think this quarter's fee income level is a good run rate.
spk05: we've had we had a few things the mortgage gains definitely was a plus but and I think we'll be able to maintain that level of mortgage gains going forward so I think this is a good run rate to use just a little more color we're so pleased that we've made that shift from using the portfolio to get back to where we have historically been which is a more of a fee-for-service model And getting to 70% sales, 30% portfolio really does change the fee income dynamic of the income statement.
spk22: Got it. I appreciate that, Keller. That's all I had. Thank you. Thanks, Danny.
spk16: Thanks, Danny. Thank you.
spk15: One moment for our next question, please. All right, and it comes from the line of Terry McEvoy with Stephens, Inc.
spk16: Please proceed. Hi, good morning, everyone.
spk21: Hi, Terry. Hey, Terry.
spk11: First question, on page 20, how much of that $261 million office portfolio will mature over the next 6 to 12 months, and what are your thoughts on the impact of updated appraisals and overall higher interest rates on that portfolio? and the possibility of either reserves or charge offs having to be taken.
spk09: Yeah. So when I look at the office portfolio, Terry, you know, the Largest names or relationships in that portfolio have a primary tenant who is, I'll call it relationship, so it's kind of owner-occupied-ish, but they occupy less than half. So it's not an office building that is in a downtown metropolitan sort of Um, configuration, it's a suburban location where, um, you know, we've got a tenant that's occupied a higher portion of the total. So, um, the concern over maturity and, you know, reappraisal and a write down. as we've kind of gone through that portfolio, is relatively low. I don't have the actual, you know, what matures in the next year or so, but, you know, we've been through the portfolio last year and feel pretty good about, you know, what we see in there.
spk11: Thanks for that. And, Michelle, a question for you. Did the outflow of non-interest-bearing funds deposits. Did that slow throughout the second quarter? And if we get a 25 basis point rate hike, all things being equals, is that a positive or negative for the net interest margin?
spk18: So on the non-interest bearing, it did slow some in the second quarter. And in fact, even just looking at June's not interest bearing and even what we've seen so far through July, it has slowed as well. That remix as in fact, in July, we haven't really seen the remix change at all. So we could still see a bit of remix. I would expect that we would through the end of the year. But as we've kind of the theme, I think of our call is that we're starting to see some slowness in that area, which is great. And I would say that on the second part of your question, you know, given that we have two-thirds of our loan portfolio repriced, typically when we see rates increase, and I think with the slowness of deposit rates increasing, I think that will be a benefit to the margin.
spk11: Thanks, Michelle. And then one last quick one, the two new non-accrual loans, either of them shared national credits?
spk09: Were they shared national credits? No, neither of them were. Great.
spk10: Thanks for taking my questions. Have a good day.
spk21: Thank you, Jerry.
spk16: Thank you. One moment for our next question, please. And it comes from the line of Brian Martin with Jenny. Please proceed.
spk03: Hey, good morning. Good afternoon, everyone. Hi, Brian.
spk12: Hey, Brian.
spk03: Nate, just one follow-up, I guess, Michelle, on the margin, and that was the, you know, I guess if you look at, you know, the margin, you know, I guess dropping, kind of all your guidance, I guess my assumption is assumes another rate hike in there for, you know, for the next meeting here, but just as you think about the dollars of NII in the second half, I mean, it's your expectation with the growth outlook, and I joined late, so I didn't miss any comments on the loan growth outlook, but it's the expectation that sequentially you can grow the dollars of NII even if the margin is you know, declining a bit here in the second half?
spk18: I think with the margin declining, I think that there could be a bit of compression in net interest income. that we would see really that what we model is the net interest margin and you know about it right now our models are telling us about a 10 basis point decline and we'll see I mean there's a lot of assumptions that go into us determining all of that and you know it's been a pretty challenge from quarter to quarter to try to determine where we think things are going to be so but that's what our assumptions are today.
spk03: Okay perfect and then you know maybe just one for you Yeah, I guess on the credit side, I know there was one question on the shared national credits, but John, I guess just anything when you're looking out there today that, you know, I guess where you're focusing more attention on or just areas that maybe you have a bit more concern on. I mean, the shared national credits was one thought, but just, you know, anything else that we should be paying closer attention to on the credit side or you are, you know, as you kind of look at the numbers and everything holding up still really well here.
spk09: This is a good question, Brian. You know, it's interesting. I look at, you know, we look at the portfolio and different cuts each quarter, and there's nothing there from a macroeconomic perspective. Interest rates have impacted borrowers with higher borrowing costs. You know, we focus a lot. We spend a lot of time with the commercial construction portfolio and the commercial real estate and, you know, the investment real estate portfolio. And So far, borrowers have been able to adjust to the higher rates, either through higher rents or just been able to absorb the increased interest costs. But that's really about the only thing I would say. We have had the senior living portfolio, but that's pretty well at this point. We've hashed through it and have really work that to a point where I feel pretty good about that as well now. So that's how I'd respond to that.
spk03: Gotcha. Okay. And if I missed it, maybe just the loan growth outlook or just the pipelines in general. I don't know if, Mike, if you... Can you just run back through that just quickly or just high-level comments? If it's not, I can go back and listen to the transcript later.
spk13: No, I'll hit them again. The bulk of our long road to the balance of the year will be coming through the commercial portfolio. We target that at that mid-single-digit run rate. When you adjust for the portfolio sell that we did, the commercial segment grew a little bit over 4% annualized in this quarter. It's 5% year-to-date, a little over that. And the pipeline in commercial is really the same as the pipeline going into this quarter. So I really feel good that the commercial business and our willingness to continue to be a relationship bank and extend our balance sheet will continue to see the growth in that single, mid-single-digit run rate.
spk05: Yeah, there is no absence of demand. We're clearly trying to make sure that in this environment we're gaining the entire relationship and that we're getting paid for the extension of credit. And so we're pretty optimistic about the communication we're having with customers. The relationships are still very strong. And just recognizing the environment has changed a little.
spk03: Yeah, that all makes sense. So, okay. Well, I appreciate you guys taking the questions in that nice quarter, guys.
spk04: Yeah, thank you, Brian.
spk16: Thank you. One moment for our next question, please. And he comes from the line of Damon Del Monte with KBW. Please proceed.
spk20: Hey, everybody. Hope everybody's doing well today. Pretty much most of my questions have been asked and answered, but just looking for a little bit more color on the broker CDs you guys put on. What's the average term of those as far as like the maturity dates?
spk18: They tend to be more on the shorter end of the curve.
spk20: So generally like less than a year?
spk18: Yeah, less than a year or two years.
spk20: Okay. And then just one kind of modeling question here. I think you guys noted you had a bully gain this quarter. Could you call out how much that was?
spk18: Yeah, it was actually just a couple of very small ones. And so I think it was under $800,000 of bully gains.
spk20: Okay, perfect. Okay, that's all that I had. Everything else was asked and answered. So thank you very much. Thanks, David.
spk16: Thank you. And this concludes the Q&A session. I would now like to turn the call over to Mark Rick for closing remarks.
spk05: Thank you, Carmen. Thanks, everyone, for your participation. As you can tell, it's an interesting time for net interest margin. We're kind of at an inflection point, and it's hard to give absolute guidance. But, you know, we just have looked back at our history, and the first quarter of 22, our margin was 303. It did increase all the way to 372 as rates were rising rapidly, and we were benefiting from a variable rate loan portfolio and our ability to lag deposit rates. And eventually that changed, and we had to start paying more for deposits, and we were additionally aggressive after the Silicon Valley failure that occurred. You know, if we landed at 339 for the quarter, we've got a 340 June. It's hard for us to come out and say, hey, we think the next rate increase causes margin to go up because we know there's still some additional modest pressure on deposits. But really looking forward to getting through the quarter, having a Q3 net interest margin number that we think kind of establishes a run rate going forward. So, We appreciate your time, and I know as you're working through all the different models and forecasts, it's a key component. So look forward to talking to you next quarter, and we appreciate your investment in First Merchants. Thank you.
spk16: And with that, thank you all for participating. This concludes the conference, and you may now disconnect.
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