First Merchants Corporation (NASDAQ:FRME) Q4 2023 Earnings Call Transcript
First Merchants Corporation (NASDAQ:FRME) Q4 2023 Earnings Call Transcript January 26, 2024
First Merchants Corporation isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Thank you for standing by, and welcome to the First Merchants Corporation's Fourth Quarter 2023 Earnings Conference Call. 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 risks and uncertainties. Further information is contained within the press release, which we encourage you to review. Additionally, management would refer to non-GAAP measurements, 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/or other quantitative information to be discussed today as well as reconciliation of GAAP to non-GAAP measures. As a reminder, today's call is being recorded. I will now turn the conference over to Mr. Mark Hardwick, Chief Executive Officer. Mr. Hardwick, you may begin.
Mark Hardwick: Good morning, and welcome to the First Merchants' full year 2023 conference call. Thanks for the introduction and for covering the forward-looking statement on Page 2. We released our earnings today at approximately 8:00 AM Eastern and you can access today's slides by following the link on the third page of our earnings release. On Page 3 of our slides, you will see today's presenters and our bios to include Mike -- our President, Mike Stewart; Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki. On Page 4, we have a few highlights of the year to include final total assets of $18.3 billion, $12.5 billion of total loans, $14.8 billion of total deposits, and $7.3 billion of assets under advisement.
On Slide 5, if you look at the bullet points under our fourth quarter results, we grew loans during the quarter by 6.6% annualized with a new and renewed loan yield of 8.01%. We also increased deposits by 4.8% during the same period and we reported Q4 2023 EPS of $0.71 per share, or $0.81 -- or $0.87 when adjusted for several one-time expense items incurred during the quarter. Those items include $12.7 million in one-time charges that include the FDIC special assessment due to several bank failures in March of '23, severance expense related to a voluntary early retirement incentive plan that we offered to employees in the fourth quarter of 2023, and the write-off of a lease agreement due to our Indianapolis regional headquarter move. Moving down to the bottom half of the page, you will see year-to-date bullet points.
We've delivered net income of $221.9 million and produced $3.73 of earnings per share for the year when adjusted for the same one-time expenditures that EPS totaled $3.8 -- $3.89. During a year where safety and soundness became the highest priority of stakeholders, we effectively repositioned our balance sheet to prioritize cash, liquidity and capital. The company's liquidity position improved by $585 million as cash increased $300 million and borrowings declined $285 million. Our tangible common equity increased by $222 million, during the year, driving our TCE ratio up from 7.37% one year ago to 8.44% at year-end. We maintain strong credit quality and top decile allowance for loan losses totaling 1.64%. I'm proud of our team of driven, collaborative and high character employees for rising to the call to deliver an enhanced and resilient balance sheet while also adding high quality risk aware loans at a clip of just over 5%, and for delivering net deposit growth of 3% for the year.
Before handing over the presentation, I would just like to thank our 2,000 plus colleagues for tackling a turbulent 2023 head on and for delivering top quartile results that we can all be proud of. Mike?
Michael Stewart: Yeah. Thank you, Mark, and good morning to all. Our business strategy that is outlined on Slide 6 remains unchanged and is a reminder that the financial results we deliver represent the durability of our business model within the primary markets of Indiana, Michigan and Ohio. We serve diverse locations in both stable rural markets and in growing metro markets. We are a commercially focused organization across all these business segments and collectively the First Merchants team is actively engaged in all of our communities, delivering the solutions listed on this page. Throughout 2023, we have remained committed to our business strategy of organic growth of loans, deposits and fee income, attracting, retaining and building our team investing in technology platforms that enhance the client experience and delivering top-tier financial metrics.
Let's turn to Slide 7. This slide validates our ability to deliver organic growth of both loans and deposits. The annualized total loan growth for the fourth quarter was 6.6%, highlighted by the 8% growth in commercial portfolio. During our last quarter call, I noted the strong commercial pipeline and that pipeline did materialize from our C&I focused regional bankers and from our investment real estate team. John has more detail to share around the portfolio mix and his detailed analysis show that nearly 70% of our total loan growth of 2023 comes from the commercial segment, which is consistent with our global portfolio mix of 75% commercial and the rest consumer. Within the consumer portfolio, we have residential mortgage, HELOC, installment and private banking relationships, and during the fourth quarter that portfolio grew at a 2.7% annualized rate.
So again, for 2023, the total loan portfolio grew at 5.1%. Mid to high-single digit loan growth is the expectation moving forward in the 2024. While the commercial loan pipeline ended the year lower than the third quarter, the current pipeline is sufficient to achieve our expected organic growth goals. As you know, loan growth can be choppy throughout any given period. The quarterly commercial loan growth trends have gained momentum since April, post the Silicon Valley bank crisis. We were purposeful in how we navigated our bank through those uncertain times and a loan portfolio sell and liquidity management are some examples, but the commercial loan growth improved each quarter since March with the fourth quarter at its high watermark for the year.
The overall economic environment in the Midwest, inclusive of the competitive landscape, affirms my expectation of mid to high-single digit loan growth with improving loan yields. Mark highlighted that our new loan yields exceeded 8% during the quarter, which is an increase of 13 basis points from the prior, and Michele has more detail to share on the positive trends in loan yields and loan types. The quarter saw total deposits growing 4.8% annualized and 3.1% for the full year 2023. The consumer deposit portfolio showed continued strong growth at over 11% annualized. This growth is inclusive of both the branch network and our private banking team. The consumer team continues to deliver consistent low-cost depository base. The commercial deposit growth during the quarter was also strong.
This was the only quarter throughout 2023 that commercial deposits grew. But both teams are focused on relationship banking and building market share and again, this page demonstrates that the fourth quarter delivered balance sheet growth. As Mark stated in the press release, our bank's liquidity improved throughout 2023. We have a strong capital position. Our team built a resilient balance sheet. So we enter 2024 positioned for continued growth. Our team is positioned for that growth and our underwriting remains supportive, consistent and disciplined. So I'll turn the call over to Michele to review in more detail the composition of our balance sheet and the drivers of our income statement. Michele?
Michele Kawiecki: Slide 8 covers (ph) our fourth quarter results. On line one you will see we grew assets by $313 million during the quarter, representing a very productive quarter for the company. $203 million was from loans which Mike just covered, and $98 million was an increase in investments reflecting an increase in value of available-for-sale securities. Deposits on line four grew $175 million leading to strong equity growth of $155 million, which you can see on line five. Pre-tax pre-provision earnings, when adjusted for the one-time charges Mark described of $12.7 million, totaled $61.1 million for the quarter. Adjusted pre-tax pre-provision return on assets was 1.33% and adjusted pre-tax pre-provision return on equity was 11.47%, all of which continue to reflect strong profitability metrics.
Tangible book value per share increased 11.7% from last quarter, totaling $25.06 at year end. Slide 9 shows the year-to-date results. The variances on balance sheet lines one through five display the work the team has done in shifting the earning asset mix through the year, which resulted in a robust increase in yield on earning assets of 1.46% year-over-year. Year-to-date, pre-tax pre-provision earnings, excluding the one-time charges, I mentioned previously, totaled $275.4 million. Adjusted pre-tax pre-provision return on assets was 1.51% and adjusted pre-tax pre-provision return on equity was 12.95%. Tangible book value per share increased $3.61, or 17% over prior year reflecting strong year-to-date earnings. Excluding the noise from mark-to-market adjustments on the securities, the company has experienced tangible book value growth every year for the last 10 years, and we are pleased to deliver another year of growth in 2023.
A graph of this is included on Slide 23. Details of our investment portfolio are disclosed on Slide 10. We sold $43 million in bonds this quarter, resulting in a loss of $2.3 million. We have sold nearly $400 million in bonds throughout the year. Total cash flow generated from the bond portfolio in 2023, including sales, principal paydowns and interest, totaled approximately $660 million, creating liquidity to put to work in a loan portfolio, pay down higher rate wholesale funding and to ensure we have a solid cash position. Expected cash flows from scheduled principal and interest payments and bond maturities in 2024 totals $282 million. Slide 11 shows some details on our loan portfolio. The total loan portfolio yield continues to increase, climbing 13 basis points to 6.71% from 6.58% last quarter.
You will see the delineation of our portfolio between fixed versus variable on the bottom right. Two-thirds of our loan portfolio is variable rate and half of the portfolio reprices within three months. That structure has allowed us to increase our interest income very quickly in response to the rising rate environment over the last two years and build capital. As I mentioned last quarter, we have $900,000 of fixed rate loans repricing during 2024 with a weighted average maturity rate of approximately 4.7%, which will provide some incremental interest income given new loans are repricing at 8.01% currently. The allowance for credit losses on Slide 12 declined just slightly from 1.67% to 1.64% of total loans due to net charge-offs incurred during the quarter of $3.1 million, which John will provide details on in his remarks.
We recorded $2.3 million of provision for credit losses on loans, which was offset by a reduction of reserves for unfunded commitments of $800,000 due to the decline in unfunded commitment balances. The result was net provision expense of $1.5 million recognized in the income statement. Note that we have $23.2 million of remaining fair value marks on acquired loans. Our coverage ratio, including those marks is 1.82%, which provides exceptional coverage if credit losses were to materialize. Slide 13 shows details of our deposit portfolio. We continue to have a strong core deposit base with 39% of deposits yielding 5 basis points or less, with a low uninsured deposit percentage and a low average account balance reflecting a diverse deposit franchise.
Our non-interest bearing deposits were 16.9% of total deposits at the end of the quarter, which was down very modestly from 17.4% in the prior quarter. Our total cost of deposits increased 26 basis points to 2.58% this quarter showing signs of slowing compared to last quarter. Although, we expect the cost of deposits to continue to increase somewhat over the next quarter or two, we expect the pace will be even slower than what we've experienced this quarter. We were pleased to be able to grow deposits during the year by 3.1% given deposits across the industry declined meaningfully in 2023. That growth was achieved while improving funding mix. We reduced brokered deposits and wholesale funding during the year and grew consumer and commercial deposits through customer acquisition and gaining a larger share of wallet.
On Slide 14, net interest income on a fully tax equivalent basis of $135.9 million declined $3.4 million from prior quarter. Earning asset yields increased 9 basis points this quarter as shown on line five, and was offset by the increase in funding costs on line six, reflecting stated net interest margin on line seven of 3.16%, a decline of 13 basis points from prior quarter. Next, Slide 15 shows the details of non-interest income. Overall, non-interest income decreased by $1.4 million on a linked quarter basis. As noted on the highlights on the slide, there were some non-customer related items impacting non-interest income this quarter, which included a $1.5 million BOLI gain, a $2.3 million loss on available-for-sale securities and a $1 million write-down of CRA investments.
Customer-related items declined a modest $800,000, which reflected a $1.4 million decline on the sale of mortgage loans, offset by an increase in fiduciary and wealth management fees. Moving to Slide 16, non-interest expense for the quarter totaled $108.1 million and as previously mentioned, included $12.7 million in one-time charges. Core non-interest expense was in line with expectations and totaled $95.4 million, an increase of $1.6 million over last quarter, driven primarily by seasonal incentive accruals. Our adjusted core efficiency ratio shown at the top right continues to be low, coming in at 55.56% for the quarter and 53.31% year-to-date. Slide 17 shows our capital ratios. Our strong earnings this quarter drove capital expansion in all ratios.
The significant growth you see on the top chart in the tangible common equity ratio reflects solid earnings and recapture of unrealized losses in AOCI. We are very pleased with the strength of our balance sheet and strong earnings reflecting a successful year amid real disruption in the industry. That concludes my remarks, and I will now turn it over to Chief Credit Officer, John Martin to discuss asset quality.
John Martin: Thanks, Michele, and good morning. My remarks start on Slide 18. I'll highlight the loan portfolio, touch on the updated insight slide, review asset quality and the non-performing asset roll forward before turning the call back over to Mark. Turning to Slide 18, on line two, where I highlight the various portfolio segments, commercial industrial loans, originated by our regional and middle market banking teams, grew the portfolio by $214 million. We came off a strong backlog in the third quarter as Mike mentioned, with good pull through. Investment real estate, on line five, also had good movement in the quarter from both new originations and with properties moving out of the construction portfolio and to mini-perm.
As the sponsor portfolio seasons, we continue to see exits from the portfolio as firms reach their time horizon, resulting in periodic exits and paydowns. As mentioned on prior calls, higher interest rates have driven additional capital investment into platform companies in order to meet our underwriting and stress criteria. Turning to Slide 19, I've updated the portfolio insights slide to provide additional transparency. In the commercial space, the C&I classification includes sponsor finance as well as owner occupied CRE associated with the business. Our C&I portfolio has a 20% concentration in manufacturing. Our current line utilization has remained fairly consistent at around 41% with line commitments increasing roughly $89 million for the quarter.
We participate in roughly $740 million of shared national credits across various industries. These are generally relationships where we have access to management and revenue opportunities beyond the credit exposure. In the sponsor finance portfolio, I've highlighted key credit portfolio metrics. There are 86 platform companies with 53 active sponsors in an assortment of industries, roughly 65% have a fixed charge coverage ratio of 1.5 times based on September information. This portfolio consists of single bank deals for platform companies and private equity firms as opposed to large, widely syndicated leverage loans. We review the individual relationships quarterly for changes in borrower condition, including leverage and cash flow coverage.
Turning to Slide 20. We continue to provide the breakout of our non-owner occupied commercial real estate portfolio with additional detail around our office exposure. Office exposure is broken out on the bottom half of the chart and represents 2% of total loans, slightly down from last quarter, with the highest concentration outside of general office in medical. I've added a chart to the bottom right with office portfolio maturities, refinanced risk appears to be low with $18 million, or 7% of total office loans maturing within the next year. The office portfolio is well diversified by tenant type and geographic mix. We continue to periodically review our larger office exposure and view the exposure as reasonably mitigated through a combination of loan-to-value, guarantors, tenant mix and other considerations.
On Slide 21, I've highlighted our asset quality trends and current position, NPAS and 90 days past due loans decreased $1.1 million to 47 basis points of loans and ORE. We continue to experience consistent portfolio performance despite higher rates with relatively consistent levels of classifieds at 1.94% of loans. We've moved past last quarter's last charge-offs with $3.1 million of net charge-offs or 10 basis points of average annualized -- annualized average loans 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 90 days past due. For the quarter, we added non-accrual loans, on line two, of $10.3 million, a reduction from payoffs or changes in accrual status of $6.1 million on line three, and a reduction from gross charge-offs of $3.7 million.
Dropping down to line nine, we wrote down ORE by $1.1 million, which resulted in NPAS plus 90 days past due, ending at $58.6 million for the quarter. So to summarize, asset quality remains good, net charge-offs for the quarter were 10 basis points and for the year 21 basis points, and for the quarter the portfolio grew at a 6.6% annualized growth rate, and both criticized and classified loans remain in check with stable delinquency. I appreciate your attention, and I'll now turn the call back over to Mark Hardwick.
Mark Hardwick: Turning to Slide 23, I'm going to review a few of my favorite charts as they take a more long-term perspective. Look at our performance. On the top right, our 10-year earnings per share CAGR totaled 10.2%. And looking at both the growth and tangible book value per share and dividends paid during 2023, total book value return equaled 23% or if you prefer to look at tangible book value per share excluding AOCI, our total book value excluding AOCI return for the year equaled just over 15%. Slide 24 represents our total asset CAGR of 12.9% during the last 10 years and highlights meaningful acquisitions that have materially added to our demographic footprint that fuels our growth. Slide 25, I've made a few edits to include replacing the word digital transformation with continued investment in.
During the last three years, we have delivered a new online account origination platform, enhancements to our commercial loan automation system, and we are just days and months away from completing four big enhancements. This week, we completed the rollout of our personal in branch account opening process, which reduces account opening times from an average of 45 minutes to less than 10 minutes while eliminating error rates by nearly 75%. It's also connected with our online account opening process that can be delivered seamlessly through either channel or both channels. We're also live or in beta with our new online and mobile platform for consumer -- customers and plan to be fully live with 160,000 customers by the end of February. The first half of 2024 also includes the completion of our new wire platform, our new online platform for commercial or treasury management customers, and upgrading the private wealth platform.
I should also remind all of you that we have a handful of one-time expenses related to temporarily overlapping systems and customer service center augmentation to handle these upgrades. We expect a first quarter charge of approximately $3 million and a second quarter charge of approximately $2 million. Through these projects, we have truly streamlined and simplified the client experience, and we will continue to focus on modest, relevant enhancements in the future. Thanks for your attention and your investment in First Merchants. And at this time, we're happy to take questions.
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