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Edited Transcript of FRME earnings conference call or presentation 26-Jul-18 6:30pm GMT

Q2 2018 First Merchants Corp Earnings Call

MUNCIE Aug 1, 2018 (Thomson StreetEvents) -- Edited Transcript of First Merchants Corp earnings conference call or presentation Thursday, July 26, 2018 at 6:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John J. Martin

First Merchants Corporation - Executive VP & Chief Credit Officer

* Mark K. Hardwick

First Merchants Corporation - Executive VP, CFO & COO

* Michael C. Rechin

First Merchants Corporation - President, CEO & Director

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Conference Call Participants

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* Brian Joseph Martin

FIG Partners, LLC, Research Division - VP & Research Analyst

* Damon Paul DelMonte

Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director

* Kevin Kennedy Reevey

D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst

* Nathan James Race

Piper Jaffray Companies, Research Division - VP & Senior Research Analyst

* Robert Scott Siefers

Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research

* Terence James McEvoy

Stephens Inc., Research Division - MD and Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the First Merchants Corporation Second Quarter 2018 Earnings Conference Call. (Operator Instructions)

We will be using user-controlled slides for our webcast today. Slides may be viewed by following the URL instructions noted in the First Merchants' news release dated Thursday, July 26, 2018, or by visiting the First Merchants Corporation shareholder relations website and clicking on the webcast URL hyperlink.

The corporation may make forward-looking statements about its relative business outlook. These forward-looking statements and all other statements made during this meeting that do not concern historical facts are subject to risks and uncertainties that may materially affect actual results.

Specific forward-looking statements include, but are not limited to, any indications regarding the financial services industry, the economy and future growth of the balance sheet or income statement. Please refer to our press releases, Form 10-Qs and 10-Ks concerning factors that could cause actual results to differ materially from any forward-looking statements.

Please note this conference is being recorded.

I would now like to turn the conference over to Mr. Michael C. Rechin, President and CEO. Please go ahead.

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [2]

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Great. Thank you, Phil, and welcome, everyone, to our earnings conference call and webcast for the second quarter 2018 ended period, ended June 30, 2018.

Joining me today are our Chief Operating Officer and Chief Financial Officer, Mark Hardwick; and John Martin, our Chief Credit Officer.

We released our earnings in a press release yesterday evening, July 25, at approximately 5:00 p.m. Eastern Time, and the presentation we'll cover speaks to material from that release. The directions that Phil just covered point to the webcast are also contained at the back end of that release, and my comments are going to begin on Page 3, a slide titled Second Quarter 2018 Financial Highlights.

Strong quarter for First Merchants. We earned $39.6 million of net income, a 64% increase over the second quarter of 2017, translates to earnings per share of $0.80, a 40.4% increase over the second quarter of 2017.

Our balance sheet grew, and you'll hear detail later on the call, grew at 7 -- $9.7 billion, 24.7% over the second quarter of 2017. We are covering healthy markets with consistent coverage as we've enjoyed annualized organic loan and deposit growth of approximately 10%. No acquisitions in the year 2018, so it's fairly clean to get behind the detail.

Coupled with a positive move in our margin, we had our net interest income grow 5.5% second quarter of this year from the first quarter.

Produces strong returns, on the next bullet point. 1.63% on return on average assets and 11.94% return on average equity, fueled somewhat by a 49.32% efficiency ratio. And as John Martin will cover later, a continuation of positive trends and loan quality moving favorably for us. And in total, all of the bullet points on the page combine for really healthy quality results we look forward to talking about at greater length, and that'll start with Mark Hardwick.

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [3]

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Thanks, Mike. My comments will begin on Slide 5, where total assets, on Line 7, increased by $368 million or 7.9% annualized since year-end 2017.

Organic growth and total loans, on Line 2, equaled $325 million or a 9.6% annualized since year-end 2017. And the breakdown is about 8.7% in the first quarter and 10.2% in the second quarter of '18.

The composition of our $7.1 billion loan portfolio, as shown on the left spot -- left side of Slide 6, continues to produce strong loan yields. And the loan portfolio yield for the second quarter of '18 totaled 5.12%, up from the first quarter of 2018 total or 4.86%.

The prime rate has increased by effectively 100 basis points over the past 5 quarters. And our loan yields, when normalized for fair value accretion, have improved 57 basis points during that same time frame.

As the graph on the right illustrates, 67% of our loans are variable rate, with half repricing daily, demonstrating the asset sensitivity of our bank.

On Slide 7, our $1.6 billion bond portfolio continues to be high-performing. Our portfolio yield of 3.47% equals the yield as of the first quarter of 2018, and the unrealized loss increased by $6.1 million to $16.4 million during the quarter as long-term rates have inched up.

Now on Slide 8. Nonmaturity deposits on Line 1 represent 84% of total customer deposits. And nonmaturity deposit growth over the year -- over year-end 2017 totaled $292 million or 10.2% annualized. And again, it was 7.6% in the first quarter and 12.6% in the second quarter.

Customer time deposits, on Line 2, represents remaining 16% of total customer deposits, an increase by $107 million from year-end or an annualized 20%.

As previously mentioned, the mix of our deposits on Slide 9 is a true strength of our company. Second quarter deposit cost totaled 81 basis points, up from the first quarter of 2018 of 65 basis points. Over the past 5 quarters, the Fed funds rate has increased effectively 100 basis points, and our cost of deposits have increased 42 basis points. That increase results in the deposit beta of 42%.

All regulatory capital ratios on Slide 10 are above the regulatory definition of well capitalized and our internal targets. We believe the strength of our 9.36 tangible common equity ratio and 13.81% total risk-based capital ratio will continue to provide optimal capital flexibility into the future.

The corporation's net interest margin, on Slide 11, reflects an improvement from the first quarter of 7 basis points. Of the increase, fair value accretion accounted for 3 basis points.

As noted at the bottom of the page, federal tax reform negatively impacted net interest margin by 13 basis points in Q1 and now 12 basis points in Q2, if you're attempting to compare to prior year net interest margin numbers.

Total noninterest income, on Slide 12, totaled $18.2 million and was slightly below the first quarter of 2018. And our gains on the sale of mortgage loans performed below expectations, primarily due to housing inventory and a little higher rates in the markets that we serve. Hedging income, was less than the first quarter by $611,000, resulting in total noninterest income of $18.2 million.

Noninterest expense, on Slide 13, performed as planned and totaled $53.5 million for the quarter. The improvements over Q1 were expected and communicated during our last conference call.

Now on Slide 14. On Line 8, as Mike highlighted at the beginning of the call, net income grew 64% over the second quarter of '17 and totaled $39.6 million. On Line 9, EPS totaled $0.80, an increase of 40% over the same period last year.

And on Line 10, for the first time, I'm kind of proud of this. For the first time in my 20 years here at the bank, we've were -- we have the pleasure of reporting an efficiency ratio below 50%, now totaling 49.3% for the quarter.

On Slide 15, we feel like the first 2 quarters of 2018 are very clean, strong earning and reflective of what you can expect from First Merchants core earnings power looking into the future.

On Slide 16, you will notice our May 10 second quarter dividend increased to $0.22 per share and the continuation of strong tangible book value per share growth.

Thanks for your attention. And now, John Martin will discuss our loan portfolio composition and related asset quality trends.

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John J. Martin, First Merchants Corporation - Executive VP & Chief Credit Officer [4]

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All right. Thanks, Mark, and good afternoon. Beginning on Slide 18, I'll be updating trends in the loan portfolio, review a summary and reconciliation of asset quality, discuss provisioning fair value and allowance coverage.

So turn to Slide 18, where you will see total loans on Line 11 grew in the linked quarter $177 million or 2.6%. We had robust acquisition and sponsor finance activity combined with construction fundings were the primary drivers in the quarter. Combined C&I and construction balances increased roughly $230 million, as shown on Lines 1 and 2.

I add a small chart -- I added a small chart on this slide next to Line 2 to help show construction utilization. It shows linked quarter construction commitments increasing roughly $93 million for the quarter, with utilization increasing from 51% to 58%. In other words, the $125 million balance increase on Line 2 mostly resulted from seasonal fundings under existing construction commitments rather than buy an outsized surge in construction lending.

As mentioned on prior calls, the dynamics of the construction in nonowner-occupied real estate portfolio are driven by project funding during the construction phase, while moving to either the bank's loan portfolio or the permanent market.

During the quarter, we saw nonowner-occupied CRE balances decline, with a shift out of the portfolio and into the secondary market, as can be seen by the $60 million reduction on Line 3.

Then finishing out the slide. On Line 12 and 13, we continue to remain below the regulatory real estate concentration guidelines of 100% of construction loans and 300% of investment real estate loans to capital.

Turning to asset quality on Slide 19. As Mike mentioned, we saw an improvement in asset quality for the quarter. On Line 1, nonaccrual loans declined $7.4 million. On Line 2, ORE declined $600 million -- or $600,000. And on Lines 3 and 4, renegotiated in 90-day delinquent loans declined $100,000 and $500,000, respectively.

This resulted in NPAs and 90-day delinquent loans, on Line 9, declining in the linked quarter by $8.6 million to $29.9 million or 40 basis points of total loans and other real estate-owned.

Finishing out this slide and moving down to Line 7. Classified assets decreased $12.1 million after bumping up in the first quarter by $25.3 million. This is a 6.8% decrease, and changes quarter-to-quarter are the normal ebb and flow at this point.

Turning to Slide 20, which reconciles the migration of nonperforming assets. We started the year, in the far right column titled Q2 2018, with $38.5 million in NPAs and 90-day delinquencies. From there, we added $2.7 million of non-accruals, resolved $6.3 million on Line 3 with $3.7 million of gross charge-offs on Line 5. This netted to a $7.0 million decrease, as mentioned before, and non-accruals -- nonaccrual loans on Line 6.

Dropping down to Line 7, we added $100,000 on ORE, while on Lines 8 and 9, we sold $500,000 for writing down $200,000.

So after changes and restructuring 90 days past due, we ended the quarter $8.6 million better than we started.

Moving to Slide 21. Provision expense in the quarter of $1.7 million on Line 3 covered net charge-offs of $600,000, which allowed the allowance on Line 4 to grow with the increase in the portfolio.

The allowance declined 2 basis points to 1.09% of total loans and 4 basis points of nonpurchased loans to 1.28%. Fair value adjustments, on Line 8, decreased $5.9 million from 43.1% to $37.2 million or $3.8 million in accretion and $2.1 million in offset charge-off. The decline in the allowance to asset coverage is directionally consistent with the improvements in asset quality and the continued improvement in the coverage of the allowance to nonaccrual loans, which now stands at 385%.

Then quickly summarizing on Slide 22. Credit remains healthy, as Mike mentioned before, and improved for the quarter. Regulatory classified loans declined in the quarter by $12 million after bumping up in the first quarter, and it remains mostly stable.

We have strong quarterly loan growth led by C&I and construction lending. And I would just say that it's a good part of the cycle, and I am pleased with the asset quality of the portfolio, while we continue to keep our attention focused on both the local and national economies.

Thanks for your attention, and I'll turn the call back over to Mike Rechin.

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [5]

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Thanks, John. I'm going to finish prepared remarks, on Page 24, called First Merchants Strategy and Tactics Overview, Looking Forward. Now I'll cover a handful of bullet points and then take questions.

So the first bullet point talks about -- a little bit about what John just mentioned. It's a good part of the banking cycle and so we are trying to do what we do best, which is to manage our market presence and deliver our core banking business in a really competitive environment using the kind of disciplines that have allowed us to grow here in the Midwest.

We've always viewed organic growth as Job One, so we're pleased with the results year-to-date. Changing environment, to some degree, on bullet point 2. So we are optimizing our retail and commercial deposit strategy. A couple of quarters back, we had talked about a proactive account migration tactic of actually just replacing checking accounts with features that more closely meet the expectations of our clients. So that project will go on through the balance of the year. And then on top of that, having just to revisit now with several rate increases, what the expectations of our client mix are in terms of product use and pricing. And so everything, from the most basic retail products to public funds, whether the role, the cost and the relationship expectations of wholesale types of accounts and commercial accounts all being revisited in a way that have produced strong results in 2018 to date.

The industry doing well means that the talent attraction remains difficult. So our success in the marketplace has allowed us to add the kind of people that we need to grow at the clip that we've been and deliver the service in a manner that's consistent with what First Merchants aspires to do in the workplace atmosphere. The culture of the company, I think, acts as an offset to the difficult talent environment that we're in. We are pleased with it.

All in, when I combine the top 3 points and the comments of my colleagues, we feel like we're in a very repeatable performance environment as we continue to build out the Specialty Finance business, as listed in this bullet point. We've seen year-to-date that with the impacts of the tax reform, we've had lesser volumes meeting our return expectations in the public finance space, while sponsor finance and asset-based continue on a healthy clip, with sponsor being the more mature of those businesses.

The loan syndications function that's included in here is going to help us on a go-forward basis take full advantage of the opportunities we have in original loan underwriting and have a distribution for the benefit of our clients and ourselves.

And that bullet points speaks to the fact that at the June 30 numbers, you can see our balance sheet wound up at $9.7 billion. So when we think about M&A as one of the avenues to cross $10 billion, we view anything in terms of crossing $10 billion as a 2019 event and planning consistent with that.

Active discussions around the avenues that might be good ways for us to grow. It's been a good year to date. Since we spoke last, that Senate Bill 2155 was passed, which had a pretty meaningful tangible benefit to us in that we can continue to rely on the internal stress testing that we've been using all through the -- since the 2009 cycle. That has really served us well and not had to reinvest or change gears around DFAST, which is no longer required of us.

In some regards, 2018 and the efficiency that Mark alluded to reminds me a little bit of 2016, the last year where we didn't have any acquisitions. And it gave us a little bit of a calm to take advantage of some good ideas that bubble up throughout the company as to how you get sharper with your delivery or more efficient in your delivery. And so when you achieve the efficiency level that Mark alluded to, it really comes from a lot of things. Not just revenue growth at the clip that we've been able to experience, but a bunch of singles that get accomplished around projects that just make us a better company. So we're pleased with where we're at. We look forward to taking that momentum through the back half of the year and into our 2019 planning.

That's the end of my prepared comments, Phil, if you had questions in queue.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Scott Siefers from Sandler O'Neill.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [2]

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Mark, maybe the first question for you just on the margins. So the core was up about 4 basis points to 3 81. So I guess, technically, you're right that it could be up less than 5 with additional rate hikes, but still pretty solid performance. I guess be curious to hear, number one, your updated thoughts as to where the core margin trajects over the course of the next couple of quarters, just given all what is the shape of the yield curve, deposit pricing, et cetera. And then number two, just on the purchase accounting accretion. It came in a little higher than I thought, but just any color to the extent you can offer on where you would anticipate the PAs coming in over the next couple of quarters as well.

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [3]

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I'll start with the fair value accretion. We had a plan of $12 million for the year. And I feel like on a go-forward basis, we still feel like $3 million a quarter is a good number. We were at, what, $3.1 million, $3.8 million. I don't anticipate that it's going to continue to run that hot, but we should see at least $3 million each quarter. And then on the core margin, we have spent a lot of time in the last quarter just re-evaluating our models for net interest income simulations. And looking at the risk of what happens in a flat rate environment, we were still, I guess, more confident that we continue to see some expansion, given rising interest rates. And so we just had the increase on June 13, which should accrue to our benefit throughout the second quarter. I don't know whether that will be 4 basis points, but I would think we could get a couple of extra basis points out of it. Ultimately, when rates stop moving, the deposit betas, we'll have to manage those on a go-forward basis, but we feel really good about the environment we are in at this point.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [4]

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Okay, perfect. And then just if I could switch gears to the fee base for a second. I guess as I look down the line items, most of them came in just a little weaker than I would have anticipated and has historically been the case for you guys. So if we're starting exclusive of the securities gains at a base of just about $17 million in the second quarter, what's your best guess for how those lines cumulatively trend here as we look out over the next couple of quarters?

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [5]

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We think that, that net number, I saw how -- I think I saw how you got to $17 million or $17.1 million off the slide that's presented. And I would think of that as in kind of an absolute floor, because there's some things taking place in that number, Scott, that are worth -- if you don't mind me sharing, a couple of items that it's in aggregate. I see where a question would come up. So the service charges were, I think, is the highest value line item in there because it comes from all of our client base, so I would continue that to grow and reflect 2017's acquisitions. The wealth management business is really comprised of 2. It's a day-to-day business that you might think of as a trust business coupled with a brokerage business. And our leadership there decided to make a change that really was probably a little bit more impactful to the way our revenue shows. And moving away from a transactional advice model towards more of an advisory fee model that will have a little bit more steady slope positively through the balance of this year and into '19 and '20. It's about a $300,000 change in the brokerage business alone in the first 6 months of 2018, maybe a little bit more than we had anticipated.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [6]

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Do you have client counts?

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [7]

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The client counts continue to grow. We had a couple of claims in the BOLI category last year that weren't repetitive. I think I saw that in through 6 months of 2017 that our line item there was $3 million, not $1 million. So in short, I'll wrap up and say that I feel like the core parts of those fee items are kind of as low as they're likely to be at that $17.1 million core number, absent security sales.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [8]

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Okay, perfect. So maybe we kind of reset the bar a little lower, but it sounds like you feel very comfortable it would grow off of it this quarter.

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [9]

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Yes, the other activity that takes place in the other line there, probably the dominant item in there is the interest rate hedges that we actively market to our clients. And we had a particularly slow second quarter. It's not a 100 kind of activity. It's a dozen or so. A dozen, maybe 2 dozen transactions in a quarter, and so we had somewhat of a slow second quarter. I think we're going to have a stronger third quarter based on what we have seen so far. So in combination, I think we feel good about this starting spot or the restart, as you called it.

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Operator [10]

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And the next question comes from Kevin Reevey with D. A. Davidson.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [11]

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So I wanted to follow up on Scott's question related to the fee income. In light of the fact that your Residential Mortgage income came in lighter than expected, given lack of inventory, how should we think about that particular line item going forward, given the continued, I assume, lack of inventory in your markets?

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [12]

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Yes, so the individual that runs our mortgage business was offering some thoughts on that. And he feels like despite the softening in the market and the availability in terms of inventory, that we have added some producers in Ohio, Columbus, Ohio, in particular, to take advantage of kind of an entrenched capability we had over there. And so I would view quarter 3 to at least mirror the second quarter, if not a little bit stronger. And that the net interest income should track to plan, our plan, which has it growing throughout because we do have a solid demand for portfolio loans that don't get sold into the secondary markets. So similar to the question or similar to the last answer, I would view it kind of as a floor level and with some build expectation from there.

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Kevin Kennedy Reevey, D.A. Davidson & Co., Research Division - Senior VP & Senior Research Analyst [13]

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And then moving along to your reserves, the non-accrual's pretty strong. And then in light of kind of the strength of the coverage ratio, how should we think about provisioning going forward?

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John J. Martin, First Merchants Corporation - Executive VP & Chief Credit Officer [14]

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Kevin, it's John Martin. Generally speaking, we can't really project into what that number is going to be. But the way I think I would model it if I were in your seat is, I would look back. Probably 8 to 12 quarters, look at the charge-offs rate and then figure, say, 1% for a portfolio growth and that should get you a good estimate if you are trying to plug something in the model.

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Operator [15]

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The next question comes from Terry McEvoy with Stephens.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [16]

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Are you seeing a shift at all within your deposit customers moving from, call it, demand savings into CDs? And the reason I ask is just a quick look at the website. You've got a 1.25% 6-month promo money market rate. And I think a 2-plus percent 13-month CD out there. And I'm just wondering whether your customers are seeing that and are reacting to that?

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [17]

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We have definitely some migration that is occurring. We are definitely being more aggressive with our interest rates in Columbus, Ohio, where we have less market share and in an aggressive way, offensive way. And our remaining markets are more legacy markets. We're in a position as a market share leader to be a little bit more defensive. So I think that is the environment. We're more interested in leading with variable rate products. If there is a view that once the Fed begins to slow down, that they could turn around and rapidly start lowering interest rates. And the goal would be to be in variable-rate product instead of fixed-rate CDs. So we have a little more flexibility when rates go the other direction. So it's a real balancing act today to maintain this great core deposit base that we have with very attractive funding and also have offensive products where we need them.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [18]

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And then a follow-up question for John. The CRE nonowner-occupied loans that were down, was that a function of just market conditions or internally your decision to reduce concentration?

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John J. Martin, First Merchants Corporation - Executive VP & Chief Credit Officer [19]

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It was the former. We have that portfolio that we go from construction to mini-perm, and as they -- as projects either move to the permanent market or our borrowers sell them, then they come out of that bucket. That's predominantly what you're seeing there.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [20]

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Just one other question while I've got you. The construction land and land development increase, is that all commercial or is there component of that connected to residential construction?

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John J. Martin, First Merchants Corporation - Executive VP & Chief Credit Officer [21]

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It is both the call codes for 1A1 and 1A2, which does include residential construction.

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Terence James McEvoy, Stephens Inc., Research Division - MD and Research Analyst [22]

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And can you break that out in terms of the growth last quarter?

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John J. Martin, First Merchants Corporation - Executive VP & Chief Credit Officer [23]

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I don't have the breakout in front of me. I don't have the breakout in front of me between those 2 line items, but I -- what I would say is that we do have some -- not a significant concentration in residential construction. Although in the Fort Wayne market, we do have some newly acquired construction capabilities. I can get the number and either include it in the next slide and add an additional line item or provide it at a later date.

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Operator [24]

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The next question comes from Nathan Race with Piper Jaffray.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [25]

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Curious to get your updated thoughts on just what type of M&A opportunities you are seeing come across your desk? I mean, is the pace of conversations increasing? And how you're kind of thinking about the opportunities in this type of environment?

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [26]

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Well, I do think, if you think about some of the regulatory change since we spoke last, I alluded to this relative to DFAST. But clearly, the larger banks got some clearance and a little bit more latitude to pursue either capital alternatives or maybe a more of a green light towards M&A. And I think that there's some trickle-down impact well down the chain locally in the Midwest, I think at about Fifth Third moved in the Chicago through MB. And I do there's some trickle-down. I think there is more activity. You asked about the magnitude of the volume of conversations, I would say they have increased. And yet, our posture towards them stays the same. We like the Midwest quite a bit. We like digestible opportunities that would somewhat lever our brand knowledge, the talent of our folks, our knowledge of the kind of customer behavior you get in those geographies. So I don't think our view has changed, but I do think, as you get this deep into the credit cycle that there are more discussions about where people are and what their futures might hold for them.

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Nathan James Race, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [27]

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Got it. That's great color. And if I could just sneak one more in for Mark. I apologize if you've already provided this, but can you remind us what the impact from Durbin will be in 2020 after you cross the $10 billion assets in 2019?

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [28]

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Yes, if we cross the first quarter, so then it would be July of 2020, the impact would be about $4.5 million a year for a 12-month cycle.

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Operator [29]

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The next question comes from Damon DelMonte with from KBW.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [30]

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On expenses, could you just -- Mark, could you just give a little color on do you feel this is a good solid core number to build off of? Or do you think there's any item that might not be recurring? Or additional expense build expected in the upcoming quarters?

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [31]

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It's a really good core number to look to expect on a go-forward basis. There really weren't any nonrecurring items of note. And we think it gives us the sales force and the back-office that we need to be able to execute. So feel like we're in a great place and we've accomplished what we wanted to post our acquisitions to prove the value of each of those acquisitions and what our new run rate looks like.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [32]

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Okay, great. And then just lastly, are you seeing some opportunity to gain market share in the Fort Wayne market, just kind of given the construction that's been happening with the branch sale that occurred during the quarter?

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [33]

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Wells Fargo.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [34]

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Yes, Wells Fargo?

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [35]

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Yes. I don't think we have seen any immediate pickup relative to that. We do feel like over the near and intermediate-term, it positions us well as they make a comment about their commitment to those markets. And we should be there to help fill if there is, in fact, a void. We also ought to benefit from the nearly 1-year mark of maturity in the way we go-to-market there as for merchants, taking advantage of the strength of what IAB brought coupled with what I think of is the horsepower. We've tried to add throughout with our own resources and really using the folks that joined us from IAB, which is the backbone of our effort.

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Damon Paul DelMonte, Keefe, Bruyette, & Woods, Inc., Research Division - SVP and Director [36]

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Got you. Okay. And then just lastly, one more for Mark on the tax rate. I think it was a little bit higher than you guys had guided last quarter. Is something in that 16.5% range a better number to use?

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [37]

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Yes, I have everyone on my finance team saying 16.5% is the right number.

All right. We'll go with that then. That's all that I had.

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [38]

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Also, Damon, I think, for Terry, he had a question and John has that answer now.

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John J. Martin, First Merchants Corporation - Executive VP & Chief Credit Officer [39]

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Yes, I was able to dig out the call code for residential construction. We had 53 -- call it, $54 million in the first quarter in residential construction balances and, call it, $70 million in residential construction balances in the second quarter.

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Operator [40]

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The next question comes from Brian Martin with FIG Partners.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [41]

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Mike or Mark, just can you talk about, maybe it's more you, Mike or John, just kind of the loan pipeline, I guess you usually give an update on just kind of how things are tracking there, for the near-term or longer-term pipeline. Just kind of getting your gauge for kind of where we're at here.

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [42]

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Longer term is difficult. But near-term, like, call it, the next quarter or 2 quarters out, we have what has found to be a reliable measure of that. And so it's on the commercial side, which is our dominant loan origination portion of the business, it's strong. So I think it's very consistent. It's 400 and -- it's just over $450 million, which would be about $70 million higher than a quarter ago and equal to the strength that we had in the second half of 2017. It's somewhat broad-based within commercial. The mortgage business. I took a question earlier, Brian, on second half mortgage results. Our mortgage backlog is 6% or 8% up from last quarter, which just kind of goes into the answer I gave to that question. So all told, I feel like it's really consistent from an origination perspective with the kind of 7%, 8%, 9% loan growth targets we've talked about. And then some of the other related items, I know John Martin tracks our line utilization, which is up about 2% from the beginning of the year and up 1% on all of our approved lines of credit from the end of the first quarter. So they all kind of point towards the ability to have our balance sheet grow kind of commensurate with what it's done year-to-date.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [43]

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Okay, that's helpful, Mike. And just, I guess, I'm hearing, I guess, maybe some from other competitors just about payoffs. I guess how would you evaluate your payoffs this quarter? Kind of more standard? Is there anything higher or lower than this quarter than what you've been trending the last couple of quarters?

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [44]

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No. Over the last couple of years, we've had quarters where you seemed to get a disproportionate amount. But we haven't had one of those in a while. It's been fairly steady on boarding of new clients and existing client growth. And then with what I would call normal repayment of loans kind of as planned. So we haven't had that.

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Brian Joseph Martin, FIG Partners, LLC, Research Division - VP & Research Analyst [45]

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No outliers? Okay, all right. And then maybe just the last one for Mark. Just you talked about kind of the margin. As long as you are getting these rate increases, I guess the thought is you bring some of that to the bottom line through the margin. And I guess, what's your outlook, Mark, on that shift from into maybe CDs and kind of accelerating it all? It doesn't sound like you think that's a near-term event. But I mean, I guess, would you expect that to get more momentum as you get into next year? Or do you feel comfortable that kind of the range where you're at, this, whatever, 16% or 17% shouldn't move all that much?

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Mark K. Hardwick, First Merchants Corporation - Executive VP, CFO & COO [46]

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The shift in the CDs, I really don't see any pickup in the way that's working. We're still anticipating that there'll be 1 or 2 rate movements this year and maybe 1 or 2 next year. So if you look over an 18-month period, maybe, what, 3 rate increases. So we feel like that's the environment we are managing right now. And so it's more about managing the what we are paying on our nonmaturity deposits. And the balancing act that I mentioned previously is about maintaining the balances at the levels that allow us to continue growing the management like we are and minimizing the costs of the funding.

So I feel really good about our strategies. We've been managing it now for quite some time, and our results are so far proving to be pretty strong.

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Operator [47]

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Seeing no further questions in the queue, this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Michael Rechin for any closing remarks.

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Michael C. Rechin, First Merchants Corporation - President, CEO & Director [48]

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Thank you, Phil. I really have nothing to offer other than appreciation for the quality of the questions and the participation. Look forward to talking to you roughly 90 days from now to discuss our third quarter results. Have a great day.

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Operator [49]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.