Good day and welcome to the First Merchants Corporation Fourth Quarter 2017 Earnings Conference Call. All participants will be in listen only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [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, January 25, 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 risk 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 sir.

Thank you, Austin. Welcome to our earnings conference call and webcast for the fourth quarter and full-year 2017. Joining me today are Mark Hardwick, our Chief Operating Officer; and John Martin, our Chief Credit Officer. First Merchants released our earnings in a press release approximately 10:00 Eastern Time today, and our presentation speaks to the material from the release. The directions that point to the webcast are also contained at the back of the release, and my comments begin on Page 3 -- a slide titled Fourth Quarter 2017 Financial Highlights. So, we announced earnings for the quarter of $24.4 million in net income, a 9.4% increase over the fourth quarter of 2016. The raw earnings produced earnings per share of $0.49 and include the combination of $6.5 million from deferred tax asset write down and acquisition expenses which total between the two $0.12 per share, Mark will speak to that in momentarily on a more separated basis for full understanding. Otherwise in the quarter, very strong net interest income which benefitted both from strong volumes and margin. The net interest margin expanded to 4.1% following the December rate moves. Otherwise, we completed the conversion of IAB really excited about that, middle of the way through the fourth quarter, the weekend of November 12. And going back to the net interest income, really strong volumes that we are earning in the marketplaces. Organic loan growth of $270 million, a 16.7% annualized growth rate. John will talk about what was our highest volume quarter of the year and comment on that later in his remarks. And then organic deposit growth of in the quarter of $262 million, a 15.1% annualized growth rate, as we continue to have a really active focus on deposit gathering in all of our lines of business.…

Thank you, Mike. My comments will begin on slide six. Total assets, on line eight, increased in 2017 by $2,155 million or 30%. As Mike mentioned, the increase was the result of both organic growth and acquisition activity. On line three, strong organic loan growth of $661 million or 12.8% is even stronger than 2016 9.5% and 2015’s 9% organic rate. M&A growth resulting from our Arlington acquisition in May and our Independent Alliance acquisition in July, accounted for $950 million or 18.5% of our growth, a combined 31.3% growth in our loan portfolio. Additionally, the investment portfolio on line one, increased by $256 million. Most of the growth was due to M&A activity and additional liquidity that we were able to put the work as well as opportunities in the municipal bond portfolio related to refunding opportunities late in the fourth quarter. The allowance on line four, and total dollars increased $9 million to $75 million in 2017 due to loan growth and the portfolio and a decline in loans covered, by fair value M&A loan marks. The composition of our $6.8 billion loan portfolio, on slide seven, continues to be reflective of the commercial bank and it continues to produce strong loan yields. The portfolio yield for 2017 totaled 4.76 compared to 4.58 in 2016 and 4.42 in 2015. This 18 basis-point improvement over 2016 and 34 basis-point improvement over 2015 was expected, given the meaningful increases in the fed funds rate and our assets-sensitive balance sheet. The impact of fair value accounting for 2017 is just under 20 basis points, which is about 1 basis-point less than the impact one year ago. So, just pointing that out, given that -- to highlight that the growth in our yields in the portfolio were really core and not fair…

All right. Thanks, Mark and good afternoon, everyone. Beginning on slide 20, I’ll be updating trends in the loan portfolio, review a summary and reconciliation of our asset quality, discuss provisioning, fair value and allowance coverage and then end with a few comments on the portfolio. So, on slide 20, total loans, on line 11, which excludes loans held for sale, grew in the quarter $268 million or 4.1%. For the year, loans were up roughly $1.6 billion, which included both the Arlington Bank and IAB portfolio. Excluding these portfolios, loan grew organically roughly $658 million or 12.8% year-over-year -- or excuse me, over year end 2016. Returning to the top of this slide and then working down, quarterly growth came from increases in the commercial and industrial loan category, on line one, of $58 million; construction loans, on line two, of $113 million; CRE owner occupied loans, on line four, of $25 million; residential mortgage loans where we grew $24 million, on line seven; and public finance of $65 million, on line seven. Two anomalous changes in the quarter to point out, were the unusually large increase in construction draws in December as well as the effect on the public finance portfolio from the change in the tax code. With respect to the construction portfolio specifically, the dynamics are driven, as I’ve mentioned in prior calls, by project funding during the construction phase while moving to either the permanent market or into the bank’s loans portfolio at project completion. During the quarter, we saw construction commitments pretty much level out and grow a little bit. But while there was meaningful draws on the existing lines that we had are already established. I would expect to see the portfolio continue to trend positively, although not at the same pace as…

Thanks, John. I’m going to move before we take questions to the page titled, looking forward, page number 26, and some summary thoughts. And Mark described this. The tax reform benefits in 2018 are going to manifest themselves in obviously a much lower effective tax rate change, and I’m calling here for something about a 10 percentage basis-point reduction, somewhere to around the 16% level. And so, the benefit of that in our press release that we covered around compensation changes and some of our other plans involving new and enhanced technologies, really excited about it. The compensation changes are intended to recognize and galvanize a really talented team that we have at First Merchants. The branding investment is going to be spent to speak to our current and future clients. And we feel like there is still some optimization in all of our work areas around where technology can help all three of those areas intended to drive greater shareholder value. Next bullet point talks about the acquisitions. We know that there are some synergies to be gained, we’re past the conversion activities of the third quarter and fourth quarter on each of the two acquisitions and yet we’re still keenly focused on the cultural integration of all of bankers that have joined our Company, knowing that they are still adjusting to the new company that they are a vital part of. Arlington case is really super, adds to two prior acquisitions, makes us even more of a full service Columbus bank, able to compete at a high level. And Independent Alliance Bank really exciting. As a matter of fact today, while we speak, there is another press conference taking place by a Will Thatcher and Mike Stewart talking about sizeable investments we are making there in terms of…

[Operator Instructions] Our first question comes from Scott Siefers with Sandler O’Neill. Please go ahead.

Mark, I appreciate your calling out those couple of unusual items in the expense base and clarifying that. So, it looks like if we net out all the noise, you’re starting from a fourth quarter kind of core expense base of about $53.5 million. I think, when we talked last on the third quarter conference call, you guys suggested we’d see a bump up in expenses in the fourth quarter and then, maybe it comes down, back down to kind of like the $51 million per quarter range, thereafter. Is that still something you guys are thinking or has there been any change in your thinking on investment spending with tax preparation et cetera?

As we work through all the financial planning aspects and including some of the raises that we talked about for our nonexempt staff, we’re really are budgeted -- we’re coming more between those two numbers. You talked about 53 and 51. And we’re kind anticipating as we go through the year that’s going to be more like 52 to 53 per quarter on a go forward basis.

All right, perfect. Thank you. And then look, let’s see, I think you said about 12 basis points hit to the fully taxable equivalent margin due to the lower tax rate. So, thanks for that color. Wondering, if you could provide sort of that same adjustment on the tax rate. So, 16% effective tax rate, what would that imply for fully taxable equivalent tax rate going forward, something in the like 21% range there?

No, the fully -- the effective tax rate is going move down to about 16. So, I’m not sure, if I’m answering the right question. And then, on the margin, it’s a 12 basis-point reduction. Because the tax exempt items won’t gross up as much.

Right. So, all else equal, I guess, we’d be talking about, if you did a 4.10 margin in the fourth quarter that the new run rate would be sort of a starting point of like 3.98, right?

That’s correct. Yes.

And then, on the tax rate, so we’ve got the lower effective tax rate, but on a fully taxable equivalent basis, I think you guys have been running in kind of like the, I don’t know, 33%, 34% range recently, fully taxable equivalent. So, just trying to get a senses, like low-20 is the appropriate number to use for an apples-to-apples. In other words, if we make the adjustment to the margins, same thing for the tax rate as well.

I’ll have to get back to you on that and move on that. We’re not all following exactly the calc you’re talking about.

Yes. We can discuss on that one offline.

Yes. There are -- I can share some of our return on asset improvements are about 18 basis points. And on a return on tangible common equity, it improves the return on equity about 2 full points just for -- that maybe what you are trying to get at is to have -- to get the same kind of impact along in ROAs and ROEs.

The next question is from Nathan Race with Piper Jaffray. Please go ahead.

Just in terms of loan pricing in the quarter, it looks like core loan yields were up a few basis points sequentially. So, obviously, I imagine that’s partially driven from some of the construction funding [ph] that you had in the quarter. So, just curious how spreads are trending and just any other commentary on just some of the competitive dynamics that you guys are seeing?

Yes. Before I get into the competitive dynamics, just the fact that we have an asset-sensitive balance sheet and we continue to see rate increases in both fed funds and LIBOR. We’re experiencing nice net interest -- I’m sorry, interest expense expansion and yield on earning asset expansion quarter-over-quarter. So, I think that’s the first item I would cover. And then, I’ll let Mike talk about the competitive aspect.

Yes. In terms of the competitive aspects, as a relates to driving pricing, I would offer that middle market C&I lending really hasn’t changed much. If you think about. John’s comments about where this increased volume came from, the municipal lending side of that would be on the lower end of a normalize yield, whereas construction draws, to your point, and sponsor financial be on the higher end. If you think about those aspects of how it moves the norm, but the actual competitive environment hasn’t changed much. The mix has a little bit of a drive in that. And I think you are right, construction projects have more risk and as such typically floating rate benefit from the rate increases and including fees that ultimately get amortized into the yield.

And the only thing Nathan I would add is that the more the higher end of the middle market and as much as we see those transactions, that’s where the pressure comes in where the super regionals are also bidding down, call it a multinational opportunity or shared national credit and the middle market kind of core in our community and the sponsor deals, that’s been pretty consistent over the last several quarters and years actually.

And just kind of thinking about deposit cost increases, we obviously saw some further pickup in the fourth quarter here. So, just curious how you guys think about deposit pricing assuming we maybe get two of rate hikes in 2018?

It’s really very similar to what John just said. That’s our largest deposit category where we are seeing pressure to move rates. And I think if you’ve averaged out all of the rate increases that we have seen this year, I mean just kind of on a daily average and then look at the increase in our deposit, so it’s about 20%. And so when you look at beta, that’s kind of where we are running today. And we think that we will continue to just see pressure on the largest categories as rates continue to rise.

Our next question comes from Damon DelMonte with KBW. Please go ahead.

So, my first question is just kind of as it relates to the margin, Mark, thanks for the color on the impact related to the FTE adjustment and the new tax rate. How are you guys positioned currently with additional rate hikes in 2018? Has your asset-sensitivity changed at all or it’s still the same?

It’s a good question. We’ve integrated our two acquisitions this year and we have all of the combined data coming out of our core system. So, it’s always nice to prove out our expectations. And we still have a very asset-sensitive balance sheet. We have $3 billion and almost $400 million of like daily repriceable loans and investments, primarily loans and primarily driven by LIBOR and prime. But, that allows us to really benefit as rates continue to rise. We’ve really modeled our margin a couple of different ways with the continued the rate hikes and if the December 1 was the last one what did we expect because we would eventually, when rates stop rising, you start to have the deposit side catch up. And we’re convinced that we have low cost deposits that perform really well in a rising rate environment, very asset sensitive assets that perform in a rising rate environment. And when the rates increase stop, we think we have the ability to increase deposits over time at a level where we control earnings throughout that period. So, we still feel very good about it even though we’ve added 30% to our balance sheet. And as we look at the margin, so this quarter was, I think what 3.90 -- I am sorry, 4.10 was the reported margin this quarter. When you take into account the impact from the FTE adjustment and the rate hike in December, are we just down a little bit, you think from this quarter on a net basis.

Not now. We feel really good about the level we reported, because the last rate hike happened so late in the quarter that we will have the benefit of it through all of the first quarter of this year. So, we really just think it’s more about adjusting the margin expectations for the 12 basis points that we’ll lose in the calculation based on the lower tax rate.

And then, with regard to the loan growth, could you just provide a little bit more color on some of the construction projects that were drawn down on? And also where your current pipeline stands for unfunded commitment?

Sure. Damon, we have about between a $1.2 billion and $1.3 billion in construction commitments, so about 50% drawn and to the total project. The portfolio, as I think I might have mentioned on previous calls, sets multifamily about half of the total with senior being a quarter and student being another call it 10%. Those are probably the biggest categories within the construction portfolio that we have. And with the draws occurring really obviously in the multifamily and that portion of the portfolio, I don’t have a break down as to what percentage grew from each of those categories.

And what’s the typical size of these loans?

Our whole position versus the aggregate, they can be 25 million to I will say 15 to as high as 30 something million and will we take a percentage of the total. We typically don’t hold the full amount unless it makes sense.

And then I guess just lastly, at $9.4 billion assets if you were to grow the balance sheet roughly 7%, which is not unrealistic, organically this year, you would effectively cross over $10 billion in asset. Mike, can you give us a little perspective on your thought as to if the deals comes along, it’s probably something you would jump on to take comfortably get you over 10 billion, but if the right deal doesn’t happen and you’re organically getting close to that 10 billion, would you guys kind of manage the balance sheet such that you could get another year out of crossing over 10 billion?

I think we would. We’re going to try and arm ourselves with some flexibility and that would clearly be absent any M&A, the ability to still take great care of our clients, operate all of our lines of business and yet try and manage the timing of that, but yes, to get through 2019, I’m sorry, 2018 absent M&A and yet still take care of our clients, I think that would probably be one of the strategies.

Our next question comes from Erik Zwick with Stephens Inc. Please go ahead.

Starting on loan growth and I apologize if I missed this in the remarks. What is your expectation for annual loan growth in 2018? And then maybe kind of the second part of the question, which of your kind of key markets -- in the Fort Wayne, Columbus present the greatest opportunity this year?

Well, I thought John, I think all of us were pleased and yet mildly surprised that the strength of the loan growth in the fourth quarter was the highest of the four and prior calls of this nature right up to the third quarter of 2017 would have had us talking about a 6% to 8% expectation. And obviously, we were a heck of a lot higher than that in the fourth quarter and somewhat higher than that in the third quarter. And so, as I think about 2018 and based on the local economies continuing to do well. I think that to be at the higher end of single digit, in 8% and 9% annualized growth rate feels about right to us. The fourth quarter, as I mentioned, I thought was somewhat of a positive aberration and John talked about a couple of other reasons why. The change in the tax law had some of our public finance business accelerate some of their activity. And then the construction draws, as John was just speaking to were at the higher end of activity there as well, somewhat of a mild winter fourth quarter, it just allowed for a more active fourth quarter. Construction season typically tapers down a little bit from the third quarter, we didn’t see that. And as we talked about, we’re at about 50% utilization of our aggregate construction line. So, still feel very, very good about it. But 8% to 9% is kind of what we’re looking at based on the plan we’ve drawn up.

Okay. And thoughts on just kind of the outlook for how the growth will be sourced geographically between the key markets?

Yes. I apologize, I missed the back half of your question. So, I think central Indiana and central Ohio are going to drive that. We really look forward to seeing a full year what our Fort Wayne entry can do for us. So, we’re excited about that. I do know that based on the strength of the fourth quarter when I -- if you see, why would I back down to the 8% and 9%, our pipelines are down modestly, based on the strength of the fourth quarter. And yet a category that we track for opportunities, which have not yet been committed to, remains really at a pretty high level. But our raw committed term sheet out in documentation pipelines are little bit lower across mortgage and commercial.

That’s great color. Maybe switching gears to M&A. What is your read on kind of bid and ask spreads today? And which markets are you seeing particular opportunities and how are you feeling about potentially getting another deal on the books in 2018?

I think our approach to it’s been really consistent about looking around our core franchise and maybe the periphery of our core franchise in the markets we go into with the high level of confidence, both about leadership that we could either have or track and marketplaces and customer behaviors that feel like the rest of the company. And so, I think there is going to be several of those opportunities. The added variable for us, and it has been this way for certainly all 2017 is to try to do something that’s not only smart from a pricing and execution risk standpoint, but keeping that $10 billion level in mind to make sure we understand the ramifications. The bid-ask spread, I think the people that run good companies would expect to be paid really full price for it. We would expect to pay one, assuming that there are synergies that correlate to those as well. So, our perspective on it really hasn’t changed.

One last one, if I could on credit. You’ve had three very strong years but net charge-offs of 5 basis points or less, even. As you look into 2018, is there anything in your as you kind of comb your credit and look at your loan portfolio that gives you any concern that we would see a material increase from this standpoint and maybe thoughts on -- does the tax perform potentially, extend this current credit cycle even further?

That’s a good question. I look at the tax reform as giving the economy kind of shot in the arm and continue to propel our customers, our borrowers. And I do see that as kind of extending the period of performance, if you will, before there is any possibility before the possibility of recession hits. And while it’s hard to predict the future as it relates to the economy, there are a lot of things that are tailwind, if you will, when I look at what’s happening. As it relates to the construction portfolio, we do have multifamily in there, we do have seen -- we do have construction that just the nature of which is well the level of rent, the lease-up et cetera. And to this point in the cycle, we’ve been pleased with the performance in the portfolio and the way it has stabilized. So, there is nothing that I see at this point that in that portfolio gives me concern. C&I borrowers continue to perform with the individual situations that -- and naturally occur in a loan portfolio. But on balance winds at our backs, so that economy is back, the Tax Cut is going to help. And I see -- just the watchful eye on the portfolio as we go forward.

Our next question is from Brian Martin with FIG Partners. Please go ahead.

Most of my questions have been answered. Just a couple little things for me. Mark, just on the accretion number, I guess, can you just give on kind of big picture on 2018, how are you thinking about that? It was a little bit higher this quarter but just in general how to put a fence around that, a range on how you are thinking about the accretion number?

What our year was 12.6 and we’re really budgeting and expecting a very similar number. I mean, I think it gets around right at 12. And that’s just using the models and having some expectation of pay-downs that would accelerate some of the accretion we get to about a $12 million number.

Okay, and pretty consistent among quarters, kind of a declining trend on that?

It’s a little declining. Yes, that’s a good question. Because of the most recent acquisitions, it seems like they are heavier at the beginning and start to tail off where you have a little bit more amortization running through and fewer surprises.

Okay, and then just on the core margin this quarter, I guess if you guys kind of peg at that 3.90 level, Mark, it sounds like it probably trends a bit higher in the first quarter, given the December hike. And then, I guess would your thought be that if you get another rate increase or two, there is maybe a lesser benefit, but still a benefit to that core margin, so that the core margin ought to be under that outlook of rates going up that 3.90 should kind of continue to step up throughout the year or does it level out? Just if you think, I don’t know it’s in your forecast as far as rate increases but just if you talk about -- if you get the bump in the first quarter, a little bit of bump from that 3.90 level on the core, how are you thinking about the balance of the year?

We in our planning process didn’t forecast additional increases, which if you look at it that way there is a little bit of pressure on deposits, even though we’re going to get a nice pick up in the first quarter from the December rate move. I would just say, if more rate hikes happen, the real question will be what happens to the long end of the curve. So, this year the long end came down when the short end came up and that’s not really optimal. And so, if we get more all it does is flatten out the curve, then I think we can expect less benefit from it. If the curve steepens, that’s obviously really beneficial to banks.

Okay. And your comment about the first quarter just as it relates to what you expect, if the deposit data stay kind of where they are at, there is still a handful of basis-point impact just from the asset-sensitivity and the December hike, is that fair to at least think as starting point for?

Maybe 2 or 3 basis points, not a lot.

Okay. And then, maybe just two other things, maybe one for Mike. Just on the commercial pipeline, Mike, can you just -- do you have the -- where that pipeline in dollar terms, absolute dollar, where it was at year end versus where it was kind of third quarter or I guess the frame of reference you had before…

Yes, I do, I can give you that. Yes. We ended the year at $260 million, which is down a $125 million from the end of the third quarter, roughly three, just less than 390. And yet when I look at the components of it, kind of consistent throughout. The debt capital markets business which would house that municipal business is down, that was in the $40 million to $50 million level, all the way through the middle of 2017. That’s down based on some of the December closings that we had. But offsetting that decline is the category that I referenced in a prior question, Brian, you might have heard it about other opportunities in front of our adjudication process, which remains really high, it’s the better part of $1 billion. That is the category that while it’s exceedingly high, I don’t have nearly the same level of confidence about its probability of closing. But, when you translate all of that, I would go back to answer five minutes ago, is that I don’t expect us to grow 12%, even in the first quarter or for all of 2018, but I do expect it to be at the high end of single digit 8% to 9%.

Got it. That’s helpful. Thanks Mike and then just last two were the fee income, just kind of when you strip out the gains this quarter on the security side kind of being around $18 million level mark. And is that kind of a decent way to think about, as you enter 2018 that run rate or kind of ramping up from that level is how to think about the fee income side of things?

That’s a little point. We have a lot of volatility that comes through couple of different categories, primarily the hedging and what happens in BOLI. And so we think if our run rate is being higher than that 18 and it’s usually from that volatility. So, the fourth quarter was relatively light in both areas.

And then, last one was, where are the CRE and C&D concentration levels today, now that you’ve got everything kind of folded in and can you just give any color and kind of where it’s sitting today?

Yes. Brian, if you look on the bottom of page 20, we have it. We have it compared, it’s lines 12 and 13. It’s 60% for the C&D and 219% for the total CRE.

This concludes our question-and-answer session. I would like to turn the conference back over to Mike Rechin for any closing remarks.

I really have very few. I appreciate everyone’s interest in listening to the progress of First Merchants. I thought it was a really strong year for us. We are pleased about it, but also we’re equally pleased to tackle 2018. Look forward to talking to you in three months.

The conference is now concluded. Thank you for attending for today’s presentation. You may now disconnect.