Good day and welcome to the First Merchants Corporation Second Quarter 2018 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, July 26, 2018, or by visiting the First Merchants Corporation Shareholder Relations website and clicking on the webcast URL hyperlink. The Corporation may make forward-looking statements about its relative business outlook. These forward-looking statements and all other statements made during this meeting that do not concern historical facts are subject to 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.

Great, thank you, Phil, and I'll welcome, everyone, to our earnings conference call and webcast for the second quarter of 2018 ended period ended June 30, 2018. Joining me today are Chief Operating Officer and Chief Financial Officer, Mark Hardwick; and John Martin, our Chief Credit Officer. We released our earnings in a press release yesterday evening July 25 at approximately 5:00 PM Eastern Time and the presentation will cover speaks to material from that release. The directions that Phil just covered point to the webcast were also contained at the back end of that release and my comments are going to begin on Page 3, a slide titled Second Quarter 2018 Financial Highlights. Strong quarter for First Merchants, we earned $39.6 million of net income; a 64% increase over the second quarter of 2017, translates to earnings per share of $0.80, a 40.4% increase over the second quarter of 2017. Our balance sheet grew and you'll hear detail later in the call grew to -- sorry $9.7 billion, 24.7% over the second quarter of 2017. We're covering healthy markets with consistent coverage as we've enjoyed annualized organic loan and deposit growth of approximately 10%, no acquisitions in year 2018. So it's fairly clean to get behind the detail. Coupled with a positive move in our margin we had our net interest income grow 5.5% second quarter of this year from the first quarter. Produces strong returns on the next bullet point, 1.63% on return on average assets and 11.94% return on average equity fueled somewhat by a 49.32% efficiency ratio, and as John Martin will cover later, a continuation of positive trends in loan quality moving favorably for us and in total all of the bullet points on the page combined for really healthy quality results we look forward to talking about at greater length and I'll start with Mark Hardwick.

Thanks Mike. My comments will begin on Slide 5 where total assets on line seven increased by $368 million or 7.9% annualized since year-end 2017. Organic growth and total loans on line two equaled $325 million or 9.6% annualized since year-end 2017. And the breakdown is about 8.7% in the first quarter and 10.2% in the second quarter of 2018. The composition of our $7.1 billion loan portfolio shown on the left side of Slide 6 continues to produce strong loan yields and the loan portfolio yields for the second quarter of 2018 totaled 5.12%, up from the first quarter of 2018 total of 4.86%. The prime rate has increased by effectively 100 basis points over the past five quarters and our loan yields, when normalized for fair value accretion have improved 57 basis points during that same time frame. As the graph on the right illustrates 67% of our loans are variable, rate with half repricing daily demonstrating the asset sensitivity of our bank. On Slide 7, our $1.6 billion bond portfolio continues to be high performing. Our portfolio yield of 3.47% equals the yield as of the first quarter of 2018 and the unrealized loss increased by $6.1 million to $16.4 million during the quarter as the long-term rates have been stopped. Now on Slide 8 non-maturity deposits on line one represent 84% of total customer deposits and non-maturity deposit growth over the year-over-year in 2017 totaled $292 million or 10.2% annualized and again it was 7.6% in the first quarter and 12.6% in the second quarter. Customer time deposits on line two, represents remaining 16% of total customer deposits and increased by $107 million from year-end or an annualized 20%. As previously mentioned, the mix of our deposits on Slide 9 is a true strength of our…

All right, thanks Mark, and good afternoon. Beginning on Slide 18, I'll be updating trends in the loan portfolio, review a summary and reconciliation of asset quality, discuss provisioning fair value and allowance coverage. So turn to Slide 18, we'll see total loans on line 11 grew in the linked quarter to $177 million or 2.6%. We had robust acquisition and sponsor finance activity combined with construction fundings were the primary drivers in the quarter. Combined C&I and construction balances increased roughly $230 million as shown on lines one and two. I had a small chart. I added a small chart on this slide next to line two to help show construction utilization. It shows linked quarter construction commitments increasing roughly $93 million for the quarter with utilization increasing from 51% to 58%. In other words, the $125 million balance increase on line two mostly resulted from seasonal fundings under existing construction commitments rather than buy an outsized surge in construction lending. As mentioned on prior calls, the dynamics of the construction in non-owner occupied real estate portfolio are driven by project funding during the construction phase are moving to either the bank's loan portfolio or the permanent market. During the quarter, we saw non-owner occupied CRE balances decline with a shift out of the portfolio and into the secondary market as can be seen by the $60 million reduction on line three. Then finishing out to Slide on line 12 and 13, we continue to remain below the regulatory real estate concentration guidelines of 100% of construction loans and 300% of investment real estate loans to capital. Turning to asset quality on Slide 19. As Mike mentioned, we saw an improvement in asset quality for the quarter on line one non-accrual loans declined $7.4 million, on line two ORE…

Thanks John. I'm going to finish prepared remarks on Page 24 called First Merchants Strategy and Tactics Overview Looking Forward. Now I'll cover a handful of bullet points and then take questions. So the first bullet point talks about little bit about John just mentioned, so good part of the banking cycle and so we're trying to do what we do best which is to manage our market presence and deliver our core banking business in a really competitive environment using the kind of disciplines that have allowed us to grow here in the Midwest. We've always viewed organic growth as Job One, so we're pleased with the results year-to-date. Changing environment to some degree on bullet point two, so we're optimizing our retail and commercial deposit strategy a couple of quarters back we had talked about a proactive account migration tactic of actually just replacing checking accounts with features that more closely meets the expectations of our clients. So that project will go on through the balance of the year and then on top of that having just to revisit now with several rate increases what the expectations of our client mix are in terms of product use and pricing and so everything from mom, the most basic retail products to public funds whether the role, the cost, and the relationship expectations of wholesale types of accounts and commercial accounts all being revisited in a way that have produced strong results in 2018 to-date. The industry doing well means that the talent attraction remains difficult. So our success in the marketplace has allowed us to add the kind of people that we need to grow at the cliff that we've been and deliver the service in a manner that's consistent with what First Merchants aspires to do and the…

Okay. We will now begin the question-and-answer session. [Operator Instructions]. The first question comes from Scott Siefers with Sandler O'Neill. Please go ahead.

Hey, Mark maybe first question for you just on the margins, so the core was up about four basis points to 3.81. So I guess technically you’re right that it could be up less than five with additional rate hikes but still pretty solid performance I guess I would be curious to hear number one your updated thoughts as to where the core margin projects over the course of the next couple of quarters just given all what is the shape of the yield curve, deposit pricing et cetera and then number two just on the purchase accounting accretion came in a little higher than I thought but just any color to the extent you can offer on where you would anticipate the PAA to come in over the next couple of quarters as well?

I will start with fair value creation, we had a plan of $12 million for the year and I feel like on a go-forward basis, we still feel like $3 million a quarter is a good number, we were at $3.1 million, $3.8 million. I don't anticipate that it's going to continue run that high, but we should see at least $3 million each quarter.

Okay.

And then on the core margin, we have spent a lot of time in the last quarter just re-evaluating our models for net interest income simulations and looking at the risk of what happens in a flat rate environment and we're still I guess more confident that we continue to see some expansion given rising interest rates and so we just had the increase on June 13 which should accrue to our benefit throughout the second quarter. I don't know whether that will be four basis points but I would think we can get a couple extra basis points out of it. Ultimately, when rates stop moving the deposit betas will have to manage those on a go-forward basis but we feel really good about the environment we're in at this point.

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

Yes, we think that that net number I saw, I think I saw how you got the 17 or 17.1 off of the slide that presented and I would think of that as an kind of an absolute floor because there are some things taken place in that number Scott that are worth I mentioned a couple of items because it's -- it in aggregate I see what a question would come up, so the service charges where I think is the highest value line item in there because it comes from all of our client base, so I'd continue that to grow and reflect 2017 acquisitions. The wealth management business is really comprised of two, it’s a day-to-day business that you might think of as a trust business coupled with a brokerage business and our leadership there decided to make a change that really was probably a little bit more impactful to the way our revenue shows and moving away from a transactional advice model towards more of an advisory fee model that will have a little bit more steady slope positively through the balance of this year and into 2019 and 2020. It’s about $300,000 change in the brokerage business alone in the first six months of 2018 maybe a little bit more than we had anticipated. Yes, the client accounts, the client accounts continue to grow. We had a couple of claims in the bully category last year that weren't repetitive I think I saw that in through six months of 2017 that our line item there was $3 million not one. So we I did, in short I will wrap up and say that I feel like the core parts of those fee items are kind of as low as they're likely to be at that 17.1 core number absent security sales.

Okay, perfect. And maybe we kind of reset the bar a little lower but for it sounds like you feel very comfortable to grow off of it this quarter though?

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

Perfect, all right. That sounds good. Thank you guys very much.

You’re welcome.

Okay. And the next question comes from Kevin Reevey with D.A. Davidson. Please go ahead.

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

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

And then moving along to, you reserve to non-accruals pretty strong and in light of trying to the strength of the coverage ratio, how should we think about provisioning going forward?

Hi Kevin, it’s John Martin. Generally speaking, we can't really project into what that number is going to be but the way I think I would model it if I were in your seat is I would look back probably eight to 12 quarters, look at the charge-off rate and then figure say a percent for portfolio growth and that should get you a good estimate if you're trying to plug something in a model.

Okay. The next question comes from Terry McEvoy with Stephens. Please go ahead.

Hi good afternoon. Thanks for taking my question. Are you seeing a shift at all within your deposit customers moving from demand savings into CDs and the reason I ask is just a quick look at the website you've got a 125, six month promo money market rate and I think a two plus 13 month CD out there and I'm just wondering whether your customers are seeing that and reacting to that?

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

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

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

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

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

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

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

Okay. The next question comes from Nathan Race with Piper Jaffrey. Please go ahead.

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

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

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

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

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

Hey guys, how is going this afternoon?

Well Damon. Thanks.

Good great to hear, Mike. On expenses could you just, Mark, could you just little color on, do you feel this is a good, solid core number to build off of or do you think there is any item that might not be recurring or additional expense build expected in the coming quarters.

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

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

Wells Fargo.

Is that Wells Fargo?

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

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

Yes, I have every one of my finance team saying 15.5% is the right number.

All right. We’ll go with that and thank you. That’s all that I have.

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

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

Okay. The next question comes from Brian Martin with FIG Partners. Please go ahead.

Hey Mike or Mark just can you talk about maybe I just wonder you Mike -- just John the just kind of the loan pipeline I guess usually get update on just kind of how things are tracking there for the near-term or longer term pipeline just kind of getting your gauge for where we're at here?

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

Okay, that's helpful Mike. Just I mean I guess maybe some other competitors just about payoffs I guess how would you evaluate your payoffs this quarter kind of more standard or is there anything higher or lower than this quarter than what you've been trending last couple of quarters.

Now over the last couple of years, we've had quarters where you seem to get a disproportionate amount but we haven't had one of those in a while it's been very fairly steady onboarding of new clients and existing client growth and then with what I would call normal repayment of loans kind of as planned so we haven't had that.

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

The shift in the CDs I really don't see any pick up in that front in the way that's working. We're still anticipating that they'll be one or two great movements this year and maybe one or two next year, so if you look over an 18 month period maybe what the three rate increases so, we feel like that’s the environment we're managing right now and so it’s more about managing the -- what we're paying on our non-maturity deposits. And the balancing act as I mentioned previously is about maintaining the balances at the levels that allow us to continue growing the balance sheet like we are and minimizing the cost of the funding. So I feel really good about our strategies we've been managing it now for quite some time and our results are so far proven to be pretty strong.

Yes. Okay, all right I appreciate the color guys. Thanks.

You’re welcome.

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

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

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