Q2 2022 First Merchants Corp Earnings Call
[music].
Okay.
Good day, ladies and gentlemen, and thank you for standing by welcome to the first merchants Corporation second quarter earnings Conference call.
Time, all participants are in a listen only mode. After the speaker's presentation, there will be a Q&A session to ask a question. During the session you will need to press star one one on your telephone keypad again that is star one one.
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 for further information.
I'm sorry for all that 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 the financial and other quantitative information.
Soon to be discussed today as well as a reconciliation of GAAP to non-GAAP measures at this time I would like to turn like to turn the conference over to Mr. Mark Hardwick CEO . Thank you Sir please begin.
Good morning, and welcome to the first merchants second quarter 2022 conference call Howard. Thank you for the introduction and for covering the forward looking statement on page two.
We released our earnings today at approximately approximately eight a M eastern.
Hopefully you have the slide presentations, but if if you don't you can access those slides by following the link on the second page of our earnings release.
You will see today's presenters and our buyers to include President, Mike Stewart, Chief Credit Officer, John Martin and Chief Financial Officer, Michelle Caveats kit.
Page four is a.
Snapshot.
First merchants geographic footprint and some relevant financial highlights for your review.
Given the close of a loved one bancorp.
On April the first to start off our second quarter, we have updated the banking center map and included our new asset totals nearly $18 billion.
We also continue to receive meaningful awards for customer service leadership and performance from publications like Forbes, Newsweek, S&P and comparably and we've updated a few of those for you at the bottom of the slide.
Now if you would turn to slide five.
Reported earnings per share for the quarter totaled 63 cents compared to linked Q1 2022 total of 91 one.
When adjusted for P. P. P income and level one acquisition expenses. Our Q2 2022 earnings per share totaled $1. One an increase of 13 cents per share or 15% over the linked Q1 2020 twos adjusted total of 88 fast.
Growth in loans of 20% and margin improvements of 22 basis points.
For most of our EPS improvements linked quarter over quarter and that 22 basis points as when adjusted.
For fair value and also P. P P, which michele will cover in a few moments our system integration of level. One is scheduled for the third quarter and the teams are working diligently to ensure a successful conversion.
We also continue to streamline the branch network as evidenced by three additional consolidations in Q2 of 2022, and another announced two consolidations planned for the third quarter of this year.
The year to date earnings per share story is similar to our quarterly results with.
Similar PPP and M&A related adjustments.
Wired to see our core performance when adjusted now our year to date 2022 earnings per share totaled $1 89.
And that's 13% percent better than our 2021 results of $1 67.
The ratios on page five are not adjusted for one time expenses, but they are.
They obviously have a negative impact.
Based on the consolidation of rules that we had to apply to level. One Michel will highlight a few adjusted ratios like pre tax pre provision earnings and the efficiency ratio later in the materials.
Mike Stewart will now provide color on our lines of business and and level, one before Michel and John will review, our financial data data and credit statistics.
Thank you Mark and good morning to all as you look at the next two slides I'll provide an update on our line of business results and their contributions within the quarter since our business strategy remains unchanged I wanted to focus on page seven titled business highlights.
The top of the page offers a breakdown of the core loan growth by our business units. It was another solid quarter of active engagement with our clients and prospects that delivered an annualized growth rate of more than 20%. Excluding the P. P. P loans and the day, one balances up level one the growth rate was nearly 40.
14% for the first six months of 2022.
The commercial segment remains the growth engine for the bank's balance sheet with loans now exceeding eight 9 billion within this segment. We added $1 1 billion of level, one commercial loans as of April 1st and first merchants team generated $360 million of organic loan growth this year.
Within the commercial line of business the commercial industrial segment C&I is the largest component of the total balances along with the year to date and second quarter growth.
John Martin has metrics. He will review later that highlights the C&I growth exceeding the $150 million during the second quarter.
Like I've mentioned before our commercial team has remained engaged in winning new clients, taking market share along with providing additional senior debt and treasury services to our clients across all the geographic markets you see represented on the map.
Within those geographies businesses continued to expand plant and equipment to meet growing demand. These.
These customers have effectively manage their income statements and while inflationary pressures are present price increases and expense management practices have kept margin and coverage ratio stable.
Their balance sheets have also remained strong when looking at working capital line of credit availability and their leverage profile line of credit utilization rates remain constant from the first quarter of roughly 45%.
Our revolver commitments have increased during this period of time due to the inflationary pressure pushing up values of working capital assets working capital cycles are not necessarily slower than prior periods as supply chain issues have not been further constrained.
Succession planning events within the ownership of middle market companies continue to be a driver for our sponsor finance team or through Aesop transactions.
We have maintained a consistent and disciplined approach towards underwriting within this segment. The growth comes from current relationships and from the extended geographic reach we added through the investment of new bankers in 2021.
The investment real estate footings have been choppy the past four quarters, but grew 3% in the current quarter.
That growth was attributed to new production and the construction loan advances primarily within the multifamily asset class.
Just on the historically low cap rates and liquidity in the secondary market, our real estate clients continue to take advantage of monetizing product projects for liquidity and taking projects to the secondary market.
We expect the investment real estate balances to remain choppy the balance of the year.
Our underwriting approach has not changed remained consistent with the primary asset classes that we focus on which is multifamily industrial warehouse student housing and self storage.
Overall businesses have deployed their PPP liquidity, therefore commercial deposit balances have reduced as noted on the bottom chart, an annualized reduction of 5%.
Post close of the level one acquisition, we did reduce their depository pricing structure to align with ours.
At the end of June the aggregate commercial loan pipeline remains consistent from the prior quarter.
CNI pipeline has strengthened and the Iot pipeline softened.
Moving on to the consumer segment at nearly 7% annualized growth loan growth was a nice reversal from prior quarters. After adjusting for the level. One closing the quarterly increases can be attributed to our HELOC and small business products, both segments experienced increasing application volumes.
Utilization rates remained consistent and our underwriting approach approach has remained unchanged.
At the end of June the consumer loan pipeline remains strong up over 15% from a year ago.
Deposit balances declined for the quarter within the consumer segment as shown on the bottom of the page we did bring the level one depository pricing in line with the rest of first merchants and most of the decline in the quarter was attributed to the strategic decision.
The rest of the consumer network experienced the regular seasonal depository fluctuations post tax season, therefore about a 2% decline.
The consumer team continued to gain new accounts through both in branch and digital online activities, our investment last year and a digital account opening process.
High point last month with over 15% of new consumer DDA is being opened through the new digital channel.
Let's move on to the growth in the mortgage portfolio.
With the close of level one are on balance sheet mortgages have exceeded $1 5 billion and grew organically in the quarter by $225 million.
The driver of this increase comes from continued strength in purchase volumes with more of our clients choosing our on balance sheet variable rate pricing options.
Given alternative returns within the investment portfolio the mortgage asset class offers better risk return our underwriting standards remain unchanged prime borrowers with the increase in 15, and 30 year fixed rates our clients have chosen our short term or variable rate mortgage solutions.
Michel will review the noninterest income to tell where mortgage gain on sales remain muted as refinancing volumes have stayed at historical levels below levels.
The pipeline for our mortgage team ended the quarter flat when adjusting for the level one team purchased and rehab volumes are nearly 60% of the current pipeline up from 30% a year ago reinforcing the macro slowdown in refinancing volumes.
Overall, the economic and business climate across our markets is stable, we continue to see the resiliency and management teams of the companies. We serve like I stated last quarter. They have solid business plans. They have solid balance sheets, and they are well positioned to effectively navigate inflationary pressures.
Ply chain and labor issues.
Our team remains responsive and ready to support our clients' needs coupled with the current economic environment. We should continue to achieve our high single digit loan growth objectives into the third quarter.
A few comments about our new level, one teammates in the markets they serve across southeast, Michigan and Grand Rapids.
I've continued to spend time in their markets with their teams and with their clients and I remain impressed and optimistic that there's strong growth culture and demonstrated track record of winning we will continue.
As a reminder from last call Terry cable has moved to Farmington Hills to lead Michigan's region and build on the synergies between level, one and our existing music, Michigan franchise and Monroe.
Greg Barnett, who led level once commercial banking effort will continue his leadership role as region president of that geography and work directly with Terry the commercial team is now preparing for the August integration date that Mark referenced earlier.
As of July 1st the mortgage business has been fully integrated and now operating under a common platform, Tim Mckay, who was named President of the mortgage line of business, along with Brad Wise Depo, <unk>, Michel Kirsten and Dan Evans did a terrific job of leading the integration effort and the <unk>.
Mortgage team now operates under the first merchants banner.
The consumer team is deep into their training regiments and preparation of the August integration Rene Malino will continue as the market leader of the 17 banking centers. Her team will get the support of over 61st merchants consumer banking professionals, who will be on site within the banking centers.
We're up to two weeks in support of the change event.
The collective organizations, we have a lot of work to do between now and integration, but that said we have made steady progress in our project status is green.
I'll now turn the call over to Michelle who will provide a complete review of the quarter results and John Martin can share the status of our portfolio Michele. Thanks, Mike My comments will begin on slide eight covering second quarter results.
You can see our balance sheet, Tom lines, one through five.
Total loans on line, two which Mike covered in detail in his remarks increased over 2 billion during the quarter with level, one contributing $1 6 billion through the acquisition, coupled with organic loan growth of $468 million.
Ms offset by PPP loan forgiveness of 59 million.
Deposits increased one $7 million during the quarter, which included $1 9 billion from the level, one acquisition, reflecting a decline in deposit balances of $266 million.
Investments on line three increased to 140 million due to the level one acquisition.
Liquidity management has normalized and we were able to use excess liquidity to fund loan growth this quarter.
This reflected in our loan to deposit ratio, which was 78, 3% this quarter compared to 74, 9% in the prior year.
Mark covered earnings per share for the quarter, which was reduced by seasonal day, one provision, which you can see online 12 of $16 8 million.
And the elevated level of non interest expense on line 14, which included $12 5 million of acquisition costs. Our stated efficiency ratio was $58 four 5%, but was a low 57, 5%, excluding the acquisition cost reflecting strong operating leverage.
Like many of our peers, we experienced further decline in the tangible common equity ratio, which you see on line six.
Along with the tangible book value per share online 26.
Due to changes in the unrealized gain loss on available for sale Securities.
These metrics are also impacted by the cash consideration of 79 million used in the acquisition of level one.
On slide nine that shows our year to date financial results.
Mark covered operating earnings per share, which was an increase of 13%, which excluded PPP fee income, which totaled $19 million in the year to date 2021 results.
And $2 8 million in year to date 2022 results. It also excluded the total merger costs of $12 5 million I just mentioned.
Pre tax pre provision earnings totaled $128 2 million year to date, an increase of $3 9 million over prior year.
Richard P. TPP return on assets was 154%.
<unk> return on equity was 13 point, 10%.
Okay.
Slide 10 shows highlights of our investment portfolio.
On the bottom right you can see we had a net unrealized loss on the mark to market of the available for sale securities portfolio of $246 1 million compared to last quarter's loss of 1.1 hundred $1 3 million as of today. This losses recovered by $50 million, reflecting its temporary.
Nature.
The top right graph shows the trend in the portfolio yield.
The yield on the portfolio increased eight basis points during the quarter and the portfolio contributed $27 6 million in income.
The effective duration is currently at 6.4 years as a reminder, we tend to take a bit more duration in our investment portfolio than peers because much of our loan portfolio is variable.
Slide 11 highlights our loan portfolio.
Yes.
In the bottom left corner you will see the stated second quarter loan yield increased 36 basis points to 4.09% from last quarters yield of 373%.
Excluding the impact of PPP loans, and fair value accretion loan yield was 396%.
Yield on new and renewed loans increased significantly from $3, two 2% last quarter to 387% this quarter, an increase of 65 basis points.
On the bottom right you will see seven 4 billion of loans were 65% of our portfolio are variable rate with 44% of the portfolio repricing in one month and 53% of our portfolio repricing in three months.
We grew out of most all of our loan floors with the Feds 50 basis point increase in May so the asset sensitivity of our balance sheet created a meaningful increase in net interest income this quarter and we will continue to do so given the forward curve.
Slide 12 shows the details related to our allowance for credit losses on loans.
On the bottom of the slide is a roll forward of our allowance balance.
With the closing of the level one bank acquisition.
The seasonal day, one allowance for the purchased credit deteriorated loans in the amount of $16 6 million as well as the seasonal day, one allowance for non purchased credit deteriorated loans that was recorded through provision expense in the amount of $14 million.
Also recorded through provision expense this quarter was $2 8 million of reserve for level ones unfunded commitments, bringing total provision expense for the quarter of $16 8 million.
Also during the first half of the year, we had net recoveries of 300000, which brought the ending allowance for credit losses on loans to a robust $226 3 million.
The coverage ratio trend as shown in the graph on the top left.
Our coverage ratio at the end of Q2 is 198% down from 2.09% from the prior quarter, mainly due to strong loan growth. This reserve coupled with the remaining fair value accretion of $37 3 million provides excellent protection as we head into an uncertain economic environment.
Now I will move to slide 13.
The total cost of deposits on the bottom left chart shows deposit cost increased this quarter by 10 basis points.
Up to a total of 23 basis points.
This increase reflected deposit pricing pressure that was present in the municipal deposit space.
Cost of consumer deposits continues to remain low although it is possible we could see some competition in pricing for consumer deposits increase in the third quarter and some of our markets.
The average consumer DDA balance continues to be elevated from pre pandemic levels. Although we did see it begin to decline in may.
Slide 14 shows the trending of our net interest margin.
Line, one shows net interest income on a fully tax equivalent basis of $134 8 million.
When you back out non core interest income items, such as fair value accretion on line two and the impact of PPP loans shown on line three our core net interest income totaled $130 7 million, which is shown on line four.
Compared to the prior quarter total of $105 1 million the increase in core net interest income was $25 6 million $18 3 million of which was contributed from the loan and deposit portfolios of level one.
Stated net interest margin on line seven totaled $3 two 8% for the quarter.
<unk> for the fair value accretion and the impact of PPP loans brings us to a core net interest margin of 319%, which is shown on line 10, an increase of 22 basis points from last quarters NIM of 297%, reflecting the asset sensitivity of our balance sheet.
We expect to see meaningful increases each quarter going forward as the fed continues to increase rates.
On slide 15.
Non interest income totaled $28 3 million for the quarter with total customer related fees of $25 8 million, an increase of $2 8 million, reflecting the addition of level one bank fees, which are primarily in service charges on deposits and gain on the sale of mortgage loans.
Wealth management fees increased 300000, and while investment management fees are under pressure due to the decline in asset values. This was offset by the seasonal collection of tax prep fees, along with fees from estate settlement.
Moving to slide 16.
Total expenses for the quarter totaled $97 3 million, which was elevated due to acquisition costs incurred during the quarter of $12 5 million.
10 million of those acquisition costs were one time charges 3 million of which was for severance and retention bonuses reflected in salaries and benefits and the remainder was mostly contract termination charges and advisory fees, which are recorded in the professional and other outside services line in the income statement and.
It did in the other category on this chart.
Excluding these acquisition costs are core expenses of approximately $85 million, reflecting the additional of level one.
Core expenses were well managed this quarter with an increase seen in salaries incentives of $1 5 million.
Okay.
Slide 17 shows our capital ratios.
I previously mentioned the decline in the tangible common equity ratio due to a OCI changes and the acquisition of level one.
This was a meaningful decline our strong earnings and increasing net interest income will create capital strengthening this ratio going forward. Additionally.
Additionally, given we have three $226 million in the allowance for credit losses, which adds to our balance sheet safety and soundness, we feel comfortable with our current capital position.
We're all our financial results reflect strong fundamentals for the quarter and we are pleased with the result.
That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John Martin to discuss asset quality.
Thanks, Michelle and good afternoon.
My remarks start on slide 18, where I'll highlight the loan portfolio, including segmentation growth in industry concentration review asset quality and the nonperforming asset roll forward before ending with a few high level comments about the current environment. So turning to slide 18.
I've highlighted on prior calls the loan portfolio is diversified and commercially oriented with concentrations consistent with segments of the economy found in our geographies.
In the quarter quarter, excluding the $59 million of PPP Paydowns the loan portfolio grew 468.
$468 million or 20% annualized we've experienced broad growth in commercial and industrial loans, including both the regional CNI and sponsor finance businesses as well as construction and public finance.
Also this quarter, we had robust residential mortgage portfolio growth customers, who are attracted to adjustable rate products with rising interest rates. While this resulted in a lower gain on sale as mentioned previously it did have the benefit of additional on balance sheet loan growth.
With respect to the level one portfolio through our initial credit due diligence process and subsequent reviews. We have we continue to gain a deeper understanding of key relationships in the credit underwriting. The loan book is similar to the existing first merchants commercially oriented portfolio and also added meaningful mortgage footings.
Have folded the commercial portfolio into our regular quarterly asset quality review process and continue to refine our credit rating.
So turning to slide 19.
This slide highlights our asset quality trends and position, we continue to have a favorable asset quality profile with non accrual loans on line, one up $3 $3 million, even after adding $9 $4 million of acquired level, one non accrual loans other real estate increased by net 200.
Dollars and 90 days past due loans were $600000 down from $2 $1 million last quarter.
This resulted in NPA and 90 days past due up $2 $1 million and as a percentage of loans and owari of 0.47% dropping down to classified loans on line seven or loans with a well defined weakness with the addition of $73 $5 million of classified loans we ended the.
Of level, one classified loans, we ended the quarter at 168% of loans.
This does represent a modest increase though.
Level continues to remain at historic lows.
Rounding out the slide net charge offs for the quarter were roughly $300.300 million or one basis point and a year to date net recovery of $300000.
Then finishing up on slide 20.
I provided the nonperforming asset roll forward, which reconciles the changes in NPA is starting in the far right column, which excludes level. One we started the quarter with $51 $2 million in NPA and 90 days past due loans and added $3 $7 million in new non accruals and resolved $8 9 million.
And existing non accruals.
With $500 moving.
Moving to <unk> $500000 in gross charge offs of one point.
$4 million in non accruals non accruals declined $6 $1 million in the quarter.
These changes along with our sales and write downs on lines, eight and nine as well as the decrease in 90 days past due resulted in a $7 $9 million NPA and 90 day past due decline on line 13.
$243.3 million before adding an additional $10 million from the 11, one portfolio in summary, our asset quality position is strong and remains stable. We continue to onboard level the level one team into our existing system wide asset quality and portfolio monitoring process and finally, we.
Have begun and continue to work with borrowers who are navigating the effects of higher interest rates.
Supply chain issues and higher commodity prices.
These challenges are unique to first merchants or its customers and as I've mentioned previously I believe our current asset quality position and allowance positions.
Positions us well to work through individual issues, our asset quality concerns as they might arise. Thank you for your attention and I'll turn the call back over to Mark.
Well. Thanks team as you can tell we always enjoy sharing our performance.
Detailed slides, which obviously this quarter was necessary.
With a really high level of transparency, we hope that.
You can see the positive story that we see every day, but in a quarter, where you have where there's a lot of M&A activity in some of the PPP impacts. It does take some time to slowdown and make sure we're sharing it in detail.
Slide 21 highlights our track record of performance over a number of years and slide 22. The same thing just sharing the CAGR and our asset growth, including organic and M&A activities to include global one.
Which as we mentioned closed on April one so.
Slide 23, as a reminder of our vision our mission.
Our team statements and the strategic strategic imperatives that guide our decision, making and I'm confident that when you look at our results and our activities. There are aligned with our brand focus cultural transformation organic growth our digital transformation, our top quartile performance financial performance and leveraging M&A is a core competency.
And I hope when you hear the story you feel like it is a true.
Holders centric business model that we believe over time produces.
Better returns.
Thanks for your attention and your investment in first merchants and Howard at this time, we are happy to take questions.
Yes, Sir ladies and gentlemen, if you have a question or comment at this time. Please press star one one on your telephone keypad again, if you have a question or comment Please press star one one.
Please standby, while we compile the Q&A roster.
Our first question or comment comes from the line of Brian Grilling her from her regroup your line is open.
Hey, good morning, Thanks, everybody.
I was curious.
Do you think about the broader landscape here.
Pretty healthy loan growth remained level one gives you.
A lot of runway in the Michigan area are there any areas that you are looking at differently now under the assumption that potentially we could be more of a recessionary environment like are there areas, where you might be leaning into or pulling back on in terms of overall loan growth in the categories within the loan portfolio.
Oh I guess.
Between Mike Stewart and John .
I can address that issue.
Yes.
Underwriting standards are essentially the same we're clearly looking at areas trying to identify where there may be.
Inflated prices.
It has been.
As cautious as possible, but I feel like what we're what we're finding is that the core strategy that we've been executing on for a number of years is working effectively.
So far we haven't really gone in to try to make any real changes to our underwriting standards.
Mike just to add this is John .
Now with rising rates it may make individual projects may be less attractive.
I'd agree with Mark I mean, our underwriting standards.
Based on sound underwriting and sound.
Business approach to the business of lending so I don't see there hasn't been any change in our policies necessarily as a result of any impending recession.
Got you that's very clear.
Sure.
Kind of thinking more strategically Marc you're probably one of the top decile terms.
Corporate managers and stewards of capital.
Do you think over the longer term with the <unk>.
The integration of potential cost savings.
Really flowing through to the bottom line.
I think that there could be deployed anything strategically that you guys look not only for the next year, but more so in the next decade of growth.
More specifically, where do you think you could potentially invest more in it.
Longer term.
Yes, those strategic imperatives that I mentioned are.
Really matter to me they matter to our team.
And I would say the investment of capital that continues to flow into our business is focused on our human capital our human assets our people.
And to the digital platforms that we think are transforming the business.
Where our physical locations and even the expertise and talent that we have.
Our focus on advice and consultation.
And we're trying to digitize.
All of the day to day, just transactional activities as much as possible.
Both from a.
User and customer experience as well as in the back office.
So just trying to make sure that our most valuable asset our employees are focused on value add activities that truly matter to.
So the customer so.
That has been our focus.
We're going to continue to be our focus and we do have a kind of a digital roadmap and.
And we're even assessing more extensively where we may be able to find some additional process automation.
Gotcha I appreciate that Greg.
I'm talking to are going to prefer straight for quarter.
Kind of the pro forma congrats on the Q2 and I'm looking forward to the latter half of the year.
Yes. Thank you.
Thank you.
Our next question or comment.
Comes from the line of Daniel Tamayo from Raymond James.
Mr. Smith.
The tomato your line is open.
Good morning, everyone. Thanks for taking my question.
Yeah, I think first.
I just like to start on the on the margin.
<unk>.
Lot of expansion in the quarter, you've got puts and takes especially with the acquisition and the repricing of the deposits. There. So just curious Michelle on your thoughts on.
How big the expansion in the back half of the year that you think we could see.
Yes. Good morning, Daniel we think we could see another 20 basis point lift from margin through the end of the year from rate increases.
A couple of assumptions that are important and that is that just assuming a static balance sheet. So no growth I mean, obviously, we will have growth portfolio, which will add more.
Margin and the other thing is that the deposit betas that we are using in that estimate are at 35%, which is probably really conservative estimate when we are expecting some deposit competition to pick up but I still feel that we will probably end up with a deposit beta that might be lower than that.
That is what we're modeling currently.
Okay terrific.
And I know this is.
A little bit a ways away, but I'm more just curious on your high level thoughts about.
What do you think happens to the margin assuming we get a stabilization in rates kind of towards the end of the year.
It seems to be diverging opinions on this.
In terms of whether or not we.
We see continued expansion or kind of peak margin in the fourth quarter of the first quarter of next year in that scenario.
I think we will still see expansion probably even in the first quarter of 'twenty three just based on the lagging deposit pricing and then also even just some of the repricing on our loan book.
And then maybe it will stabilize after that.
Okay I.
I appreciate that.
Maybe just one last one on capital.
So you mentioned being being very comfortable with capital.
I understand that given.
The ACL in regulatory capital ratios, but with the TCE down just over 7%.
Does that impact your the way you look at repurchases and M&A I mean, do you want to get back to 9% before you consider those or do you think you can do both at the same time.
Yes, it's a great question.
Okay.
9%.
As I've stated target.
Maybe a little higher high we're doing.
Lot of capital analysis, right now because we have.
Debt that matures next year and just looking at.
What is the optimal use of hybrids, but.
Yes.
In terms of share repurchase we're definitely on the sidelines at this point.
If we were to find an acquisition.
Late 'twenty three early 'twenty four somewhere in that ballpark it it would probably need to be with more stock.
Which does put a little additional pressure on some of the EPS accretion analysis that we'd like to see so.
Our focus I've got to tell you right now is about delivering results based on the current acquisition and.
We're really excited about finishing in 'twenty two.
Delivering on all of 2023 with the.
The new geography, and the new balance sheet that we have so.
Okay.
I don't want to make M&A a priority your Pat you asked the question. So im just sharing some of our thoughts but.
Yes.
We're in a great place to perform over the next 18 months or so.
We're not going to mess that up that's where the priority is.
Alright, great. Thanks, Thanks for taking my questions.
Thank you.
Our next question or comment comes from the line of Terry Mcevoy from Stephens.
Mr. Mcevoy your line is open.
Hi, good morning, everyone.
Good morning.
Maybe a couple of questions on level could you make some comments if possible and client and employee retention and then as it relates to the cost savings from the transaction.
Where you are right now in terms of achieving the cost savings and when do you expect to hit that full run rate.
This is Mike Stewart.
Talk a little bit about the level, one client and <unk>.
Employee retention are very good at the macro level.
<unk> based across the spectrum has been very consistent very patient and very willing to work with us through the change event.
They've got a strong belief system that first merchants can deliver on additional capabilities and they're looking forward to adding that to their.
They are winning tradition so.
I feel good about the people.
Really low turnover.
Moreover.
We've been able to Utah.
Utilize some of the staff that might not otherwise have stayed in the company to fill open positions in our banks. So it's been a really good transition thus far the client side also.
Very stable.
When I make those comments about how optimistic I get around the greater Michigan marketplace Detroit marketplace. It comes from the idea that or the fact that I see their existing clients already utilizing first merchants for larger loans additional products and services. So those clients are actually in a buying mode.
With us now and we haven't even gone through the integration and so on a whole.
<unk> balance sheet and the client.
Volumes have been very stable.
Let Michelle answer the other part of the question Yeah. Good morning Terry.
So we had estimated 30% cost savings on the deal and we're actually really pleased with our ability.
To take that cost out. So currently we are carrying probably about $2 7 million per quarter in cost relative to integration team members. Their core processing expense that we think will go away come Q4.
But like I said, we feel like once that cost goes away and we get to Q4, we will have achieved.
We will have achieved our target of the 30% cost savings.
Okay.
Great. Thank you Barry this is mark.
I do think it's interesting remote work has changed the operating environment for really all banks.
And from an M&A perspective, we've seen a pretty dramatic change Mike Stewart mentioned I think we have it.
At least 30, if not 32 or 33 people that have taken the open positions with first merchants because they have the ability to work remote.
That normally would have left the company for cost savings reasons and going to work somewhere else in the geography, because we needed those positions to be in our centralized headquarters.
So it's exciting to be able to retain an extra 30, plus people that are talented seasoned mostly administrative bankers.
Can join our team and work remotely.
One of the nice attributes of how the work environment has changed.
Okay I appreciate the color there. Thank you and maybe one last question for John Martin The sponsor finance portfolio. It was up in the quarter I guess, what are you doing and what are you seeing in that portfolio today.
So the portfolio itself kind of ebbs and flows as we have.
Portfolio companies to individual sponsors that.
Get refinanced out or the fun closes and as they do the.
Names in that.
Start to pay out and are otherwise liquidate in.
Windup, reducing balances likewise in the quarter.
We continue to see.
Strong we saw strong growth from sponsors as well as adding sponsors I'll let.
SKU add too to that comment from a marketing and sales perspective.
Yes.
From a credit point of view there are 61 portfolio companies in that book and we track various credit metrics in the portfolio from leverage profile from fixed charge coverage ratio from <unk>.
Enterprise value has never been better the metrics are as strong as they've been in the past eight quarters.
Great I appreciate that thanks, everyone.
Thank you.
Thank you our next question or comment comes from the line of.
Demand delmonte from K B W.
Standby.
Mr Dong is open.
Thanks.
Good morning, everyone and hope everyone is doing well today.
So for any questions just wanted to good morning yourself just wanted to circle back on the expense outlook.
You guys had identified.
$12 5 million of merger charges and you had alluded to 10 of it being kind of onetime in nature with the other $2 5 million. What you just mentioned about integration costs and members that are.
Still on the books for the next couple of quarters is that what that difference was.
Yes, that's correct.
Yes, that's the one quarter really.
Next one quarter so if.
Can you kind of give us a little direction is how the.
The cadence of expenses will go over the next few quarters as you complete the integration and those costs roll off.
You kind of come down a little bit in the third quarter, and then maybe bottom out in the fourth quarter or any insight would be great.
Sure.
No.
Bringing out the $10 million in one time charges.
Next quarter that will bring you down to an average of $87 million and then.
When we do our integration obviously, the other $2 7 million will come away in the fourth quarter. So you really kind of looking at just a static run rate of about $84 million that would be the normalized level I do think that we could see.
Some wage growth through the end of this year and so we may end the year, a little bit up from that but hopefully that gives you kind of a color of where you see us trending through the rest of the year.
Got it okay. That's helpful. Thank you.
And then how about on the fee income side of things.
Do you think that this quarter's core level is a good run rate are you seeing any.
Any additional pressures.
From any of the fee sources.
I think this quarter is a good run rate.
Looking at like mortgage loan sale gains I feel like that's kind of at a low point.
We're retaining quite a bit of the portfolio and so I feel like that should be pretty stable, assuming buyer activity doesn't slow significantly and so I think this quarter is a good run rate to use for a combined level one first merchants.
Okay, Great and then just lastly, I think you guys booked about $3 2 million in fair value accretion this quarter.
Do you expect something in that $3 million range over the next few quarters until some of those loans.
Turn off the books.
Yeah I do.
Okay perfect Alright, that's all that I had thank you very much nice quarter.
Thank you.
Thank you.
Our next question or comment comes from the line of Ignacio Gonzalez from Piper Sandler Mr. Gonzales. Your line is open.
Hey, good morning, everyone. My questions were asked but thanks for the color.
Thank you.
Our next question or comment comes from the line of Brian Martin from Janney Company standby.
Mr. Martin Your line is open.
Hey, good morning, guys. Thanks for taking the question just kind of wanted to get a sense Michelle just I appreciate the color on the on the margin outlook and just expectations with debated, but just as you kind of go forward can you just remind us now with the <unk>.
Consolidation with level, one just kind of what's what's repricing I think you said most of this stuff is burnt through the Florida, but just kind of what's variable rate today that is moving right away that.
As we think about these next couple of rate increases just kind of how that plays in.
Then the deposit beta.
Your assumption on the deposit betas are they in the 35% does that start.
Is it 35% with the next hike or is it kind of move up to that level as you get between now and year end and your assumptions.
Okay, Yes, so let me start with the with the loans and $7 4 billion of our loans are 65% are variable rate.
<unk> 5 billion of that re prices in one month 6 billion re prices in three months and really primarily the rest of it re prices over the course of 12 months and so a variable a very high percentage of variable rate loans, and so that gives us some great lift on the deposit betas.
The 35% is through the cycle and we do think that it'll start off a little bit slower and then pick up.
Two more towards the end of the year and in the first quarter of 'twenty three.
Got you Okay. That's helpful and then how about just on.
Maybe one for John .
John just as far as the credit quality side. It sounds like you guys are monitoring it and whatnot and I guess, but just where the ACL is at today following the acquisition here and.
Health of the portfolio I mean, how do we think about that over the near term, especially given.
I guess it sounds like things are still very very strong.
Yeah, So I think David the way I would answer the question is we're continuing to review the book and the way the allowance. The ACL works for US is that I am putting individual's specific reserves on loans and from that perspective, though.
Specific reserves are relatively modest amount of the total allowance so.
And so.
Thank.
Where we're at we're going to probably continue to trend down.
And.
You'll start to see the allowance relief assuming market conditions to continue to remain stable.
Perform at the levels. They are right now sorry, Brian I mean to call you Damon there.
That's okay I got it no worries.
And then okay I appreciate that John and maybe just the last one for me was just as far as the you guys mentioned some.
Further branch closing some this quarter and next quarter I guess is it is there more of this to come or is this kind of the bulk of what you guys are expecting to do on the on the branch closure front until a handful I think he said two or three in the next quarter third quarter, but just how we're thinking about that going forward.
Yes.
Yes, we did 17 consolidations last year.
Quite a bit of fewer this year.
Continuing to evaluate our highest performing locations to those that are.
Love on the lower end of the.
Of the performance spectrum.
In terms of monitoring balances and even probably more importantly, just transaction levels.
Where we see customers moving to our digital platforms and kind of requiring.
The branch locations physical locations at a lesser level.
Assessing opportunities so.
We don't have anywhere near the number like 2017, we did a year ago.
We are going to continue to just look for opportunities to be efficient and redeploy capital into digital channels and the people.
Yeah that makes sense I appreciate it mark so okay. Thank you for taking the questions and nice quarter you guys. Congrats on the deal and getting it closed and how things are going.
Thanks, Brian Thank you Brian .
Thank you I'm showing no additional questions in the queue. At this time I would like to turn the conference back over to Mr. Hardwick and management for any closing remarks.
Thank you Howard.
Thanks for the time, everyone today, when I, when I think about our quarter and the remainder of 2022.
I'm enthusiastic I think we have a great story, we have we always talk about our ability to grow organically in the mid to high single digits.
Obviously, we exceeded that this quarter and and I think our organic growth story has really strengthened by the addition of level one.
And the Detroit MSA that we now serve.
In a more robust way with both.
Location south of the city.
In the city and also on the north and West sides.
We're an efficient organization and we've always had a strong.
Efficiency ratio relative to peer.
And even though we are investing in the company through people and technology in a way that I'm done I'm proud of that I think allows us to have a long term.
Strategy and long term success.
Operating leverage that comes out of the acquisitions and streamlining the branch operation et cetera.
Just allow us to continue to produce those kinds of results our confidence level is incredibly high and.
And we think given where the price to earnings multiple is right now that there is great upside so.
It's an interesting time the world has.
Some uncertainty.
Facing it but I think first merchants is incredibly well positioned to weather whatever comes at us and to come out on the on the back end of that.
As one of the strongest spanx.
In the United States So.
We're going to we're going to keep delivering and keep working hard for for all of you. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program you may now disconnect everyone have a wonderful day speakers standby.
Okay.
Yeah.
The conference will begin shortly.
As Johan during Q&A, you can dial star one one.
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Okay.
Yes.
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