Good day, and welcome to the First Merchants Corporation Third Quarter Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.I would now like to turn the conference over to Michael Rechin, President and CEO. Please go ahead, sir.

Thank you, Chuck, and welcome to our earnings conference call and webcast for the third quarter ending September 30, 2019. Joining me today are Mark Hardwick, our Chief Financial Officer and Chief Operating Officer; and John Martin, our Chief Credit Officer. First Merchants released their earnings in a press release this morning at approximately 8:00 Eastern Time, and our presentation speaks to material from that release. The directions that point to the webcast were also contained at the back end of the release, and my comments will begin on page 4, a slide titled, Third Quarter 2019 Highlights.So our quarter's signature event was the legal closing of the acquisition of Monroe Bank & Trust, MBT Financial Corporation, which was completed September 1, 2019.So the third quarter results that I'll cover and John and Mark as well capture one month of their results within First Merchants Corporation. The front end of the release then contains several of the details of the financial results, including the company having earned $36.8 million in net income or $0.71 per share. The results include acquisition-related expense, totaling $11.2 million or $0.17 per share. Total assets of the company totaled $12.3 billion, and grew by 25.9% over the end of the third quarter of 2018.Our annualized organic loan growth for the quarter was 3.1%, and our annualized organic deposit growth 16.4%. I look to speak more about our balance sheet activities near the call end. The bottom of page 4, our tangible book value per share of $21.26 is an annualized 15% increase since the fourth quarter of 2018.Mark's going to walk us through in greater detail the financial results for the quarter.

Thanks, Mike, and good afternoon, everyone. My portion of the presentation will begin on Slide 6. Our total assets, on Line 7, increased by $2.4 billion or 32.9% on an annualized basis of this year and now total $12.3 billion. Total loans, on Line 2, have increased by $1.1 billion this year or 19.9% on an annualized basis. Acquired loans totaled $731 million, as organic growth totaled 6.4%. Investments, on Line 1, increased $856 million or nearly 70% annualized since year-end due to strong deposit growth and acquired liquidity. Additionally, on Line 4, goodwill and other intangibles increased by $110 million, net of amortization due to the purchase of Monroe Bank & Trust on September 1 2019. The composition of our $8.3 billion loan portfolio shown on the left side of Slide 7 continues to produce strong yields of 5.28% or 5.15%, excluding fair value.As the graph on the right illustrates 65% of our loans are variable, demonstrating the asset sensitivity of our bank. Monroe's portfolio mix is very similar to our core loan portfolio with a slightly larger concentration in owner-occupied real estate and mortgage loans in a slightly more fixed-rate bias.On Slide 8, our investment portfolio has a longer than peer duration, which is a good offset to our variable rate loan portfolio. During the year, we've increased the portfolio to $2.5 billion from $1.6 billion at year-end 2018, to deploy excess liquidity and to protect the bank against falling interest rates. As of December 31, 2018, our unrealized loss in the portfolio was $8 million. Over the first three quarters of 2019, as rates have fallen, the unrealized loss has become an unrealized gain of $75.8 million.On Slide 9, total deposits increased by $2 billion year-to-date. Monroe Bank & Trust accounted for $1.1 billion of the growth,…

All right. Thanks, Mark, and good afternoon. I'll begin my comments on Slide 19 with changes in the loan portfolio, review asset quality and the asset quality roll forward, cover the allowance and provisioning and then close with some summary remarks. So turning to Slide 19. In the third quarter, the loan portfolio grew $59 million or a little less than 3.1% annualized, as Mike mentioned earlier. Loan production was a little lighter this quarter, coming off of strong second quarter that saw the loan portfolio grow at an annualized 12% rate. With the exception of CRE nonowner-occupied loans and ag lending, on lines 4 and 6, respectively, all other areas of the portfolio has posted increases. We've seen strong demand for investment real estate in the secondary market, which has resulted in early payoffs and refinancing in the CRE non-owner-occupied book.Despite this, we continue to see good demand for our commercial, industrial credit, including owner-occupied commercial real estate as well as Private Banking, where portfolio mortgages grew $16 million on line 9. The MBT loan portfolio contributed $731 million to the balance sheet with a similar composition to the existing loan portfolio and results in total loans at the end of the quarter of $8.3 billion. And finally, on the bottom of the slide, our concentration -- our construction concentrations continue to hover around 50% of risk-based capital with the investment real estate concentration, hovering around 220% of risk-based capital. These levels give us ample concentration room for real estate growth as opportunities present themselves.Turning to the asset quality on Slide 20. Asset quality remains stable and healthy. On the line 1, nonaccrual loans decreased in the pre-MBT portfolio for the quarter by $8.4 million to $17.2 million or 23 basis points of loans with other real estate owned…

Thank you, John. Since our last call on July 25th, we had a legal closing on September 1st, as we mentioned. We announced a stock buyback program. We made material advances in our seasonal modeling for implementation next year, and we completed the quarter of financial results. So we feel very positive about the results that Mark and John just spoke to. And as Mark covered, we kind of -- we were able to outrun the net interest margin pressure to grow net interest income independent of MBT. We had strength in several fee categories, stronger maybe even in the totals that are depicted on page 13. And that bond gains were down in the third quarter, and we had a 6-figure vendor rebate in the second quarter that we had to normalize from. Our client-centric fees in the third quarter really grew nicely. Service charges, wealth management fees, gain on sales of mortgages and our customer derivative sales were all up. And while derivative sales are probably least easy to forecast going forward, the other categories I mentioned, continued strength in our wealth business, our service charges through the use of client-facing technology, and our mortgage business clearly look like they're going to stay stronger here in the near term.Our expense management, I think, was strong. It was highlighted well in the release and in Mark's comments. And all of the opportunity we saw in expense savings relative to Monroe appear to be there, many of which have been realized and some of which will come to us on the back end of the current quarter's integration activities. John spoke to the asset quality, both on the overall portfolio, a really stable and I think actively managed. And I also feel like as he said, we have a great…

[Operator Instructions] And our first question will come from Scott Siefers of Sandler O'Neill.

Guys, how are you?

Good Scott, how are you?

I'm good. Thank you. I think just a couple of question. Maybe Mark, start out with you. If you could walk us through where you're rate sensitivity stands now? I think from my perspective, the margin declined but consistent with what you had said in July. And if anything, the rate environment got a lot tougher in the interim than versus now. So I would've expected if anything worse. So maybe just any changes in the rate sensitivity?And then last quarter, your had sort of suggested the same 3 to 4 basis points hit from each 25 basis point cut, as you articulated a moment ago. But at the time, it seemed that you might have thought something like 5 basis points was more realistic. I think that was predicated on still deposit pricing pressures. It feels like you might be a little bit more confident in the 3 to 4 now. How are you thinking about those dynamics as well?

We were anticipating, I know we said it on our last call that we thought the third quarter margin will be down around 10 basis points and down and 9 on a reported basis, 10 if you back out fair value. So we feel good about the guidance that we had in the third quarter. This is the first time that we feel like deposit costs have finally peaked, or it's the first time we've really been confident in that.As we've had increases in prior quarters of 12, 16, 14, 9, just kind of going backwards. And so it's good to see our interest expense on interest-earning deposits only up 1 basis point. And that was with Monroe just for 1 month of the 3. And they helped stabilize our interest expense on deposits even more going forward.We know that as the prime rate comes down, we're still asset-sensitive, not as much as we were 4 or 5 quarters ago. As we have taken some steps primarily in the bond portfolio to just extend term. And the asset, the loans that we acquired from Monroe are a little more fixed rate than the rest of our balance sheet.So I do feel like instead of being more, like, 5 basis points in a declining rate environment that we'll be able to have better success on the deposit side and keep the net interest versus margin compression more like 3 or 4 basis points.

Okay. Perfect. That's helpful. And maybe a more take a tack one on the purchase accounting benefits expectation going forward. About 9 basis points help to the margin this quarter, what would be your best guess as we look into the subsequent quarters?

I think we have to kind of model it the way it is. The way -- at our current run rate, 9 or 10 basis points. And we've had experienced in the past where immediately after an acquisition, it seems to ramp up a little. But 9 to 10 basis points, I think, is still the right guidance and the right modeling.

Perfect. And then if I can slip one final one in there. The expense base came in quite a bit better than what I would've thought. I know there's some noise with the FDIC stuff. But maybe your -- some extended thoughts on exactly what happened that allowed them to stay so low in your outlook going forward?

Yes. I think if you go back to our second quarter of '19, just excluding Monroe and a normalized FDIC expense level, we were close to $58 million. And when you include Monroe on a go-forward basis, we think that Monroe, for an entire quarter, is more like $7.5 million of expense. So we think if you look at those 2 together, that gets to be closer to what the run rate should be on a go-forward basis. And yet, in the fourth quarter, we still have some FDIC benefit that will recognize. So we had an income of $700,000 this quarter. Next quarter, the number should be zero.And so that will help us again in the fourth quarter, and then we get back to a run rate that is more kind of third quarter plus the $7.5 million of Monroe expenses. This particular quarter, we only had Monroe for 1 month. And it was a strong quarter and partially because our acquisition closed a little later than what we traditionally have happened in most announced mergers. And we've been able to take out quite a bit of the expense already. So even though the integration is scheduled for this -- in the fourth quarter, in November, we don't have as much of benefit to recognize post merger, a lot of that has already been done.

Okay. Perfect. So it sounds like the expense is sort of low $60 million per quarter going forward on an all-in basis then.

Yes. We think low to mid-60s is kind of the go-forward level.

Because of the FDIC.

And FDIC will be the biggest variable in the fourth quarter and then again next year as it increases as part of the large bank acquisition cost.

Yeah, got it. Thank you very much. Appreciate the color.

Thanks.

The next question will come from Terry McEvoy of Stephens. Please go ahead.

Good afternoon, everyone.

Hi, Terry.

Maybe a question on just the liquidity or excess liquidity. The loan-to-deposit ratio went from 90 to 85 after the closing of the acquisition. Just what are your thoughts on managing liquidity, that loan-to-deposit ratio over time is 90, closer to the targeted level you'd like to operator at?

Yes. We think 90 is an optimal level to operate at. And I think we have a nice track record acquisition to acquisition of ramping up the growth or the momentum that comes out of each market that we acquire, that ultimately uses the acquisition -- the liquidity that is on the balance sheet. So we feel great about the position and where we stand today, but on an organic basis, our loan growth always exceeds deposit growth, especially over time.

And then just as a follow-up, you mentioned you repurchased $19 million of stock in September. Do you have just the period-end share count. I didn't see that in the release. Just the kind of be helpful for the fourth quarter shares in our model? And then, what are your thoughts on additional repurchase activity from here?

We announced $75 million. We have seen an uptick in the price the last week or so, which is obviously good for shareholders. I mean we're just going to be opportunistic as we use the remaining amount of that $55 million, $56 million. And the period-end share count, I'll get for you in just a moment. Yes, it's in our press release. On the balance sheet, 55,345,672, 55,345,672.

Our next question will come from Nathan Race of Piper Jaffray.

Mike, curious to get your thoughts on just kind of loan growth outlook from here. Little softer production seasonally, perhaps, here in 3Q. Curious kind of where the pipeline stands? If you would anticipate any runoff at MB&T? And if you, I think last quarter, you kind of talked about some of the disruption in some of your, so I'm just curious if there's been any hires to date to speak of?

Yes. Let me speak to the dollar volumes first at the front end of your question. So yes, in terms of period-end to period-end loan growth, I thought it might have trended a little bit higher. Our loan closings in the quarter would've supported a higher number in that. The pipeline, the commercial pipeline that we had at the end of last quarter, about $460 million, we had a lot of closings.Predominantly in those business lines that stick to our balance sheet, like consumer lending and our structured finance group and traditional commercial banking. We also had a lot of loan closings in a strong mortgage business like most entities that are in residential mortgage. I mentioned in my earlier remarks that we had loan utilization down a couple of percent on $2 billion is about $40 million. I don't know if that's tariff-related.I really don't have a good understanding of the borrower by borrower, other than it tends to move in a fairly tight number. Our pipeline going forward is even stronger than the $460 million commercial pipeline we had a quarter ago. It's actually about $100 million higher. $560 million, and it's broad-based. It's in our structured group. It's in Ohio. It's in the Indianapolis.And so that when I think about market disruption, it didn't really manifest itself for us in people ads because I like the team that we have. It really just plays into more opportunity, more chances to share term sheets and of ideas. And while the third quarter might have been a little bit lesser than I expected, we're off to a fast October start.So any of the annualized numbers in that 6% to 8% range that we used, we continue to feel good about independent of what takes place in Monroe. We don't know that market place like the bankers do that joined us. So they're obviously going to be leading their efforts, taking a, hopefully, a calm through the integration period to let them get used to us, but we clearly have the horsepower to make their growth plans happen.And again, we like the talent level, the bankers that are joining us, so we feel good about it. And the client feedback we're getting about their 2020 plans is also upbeat. So we're ending that year confident.

Got it. That's great color. So it doesn't sound like you’re expecting any runoff, perhaps, intentional on the MBTF side of things?

No. We really don't. John identified some of those specific nonaccrual numbers, which are really quite modest. I think they're $5 million. But behind that there -- to your point, there is not a list of names that have an asset quality profile that suggests we shouldn't be serving them anymore. So no, they're going to -- they're not really starting out at all with the yellow light. It's kind of green, once we get the integration activities completed.

Got it. That's great to hear. And if I could just ask one more housekeeping question. The tax rate, little light this quarter. Mark, where you expect it go back close to 17% going forward?

Yes. We think 15% in 3 quarters, the 16% is a little bit more normal.

Great, I appreciate all the color guys.

Thank you.

The next question will come from Kevin Reevey of D.A. Davidson. Please go ahead.

Good afternoon. How are you?

Great, Kevin. How are you?

Good. Thanks. So first question is, earlier in your prepared remarks, you'd mentioned that you're going to remain disciplined with respect to pricing. I'm just curious how comfortable you feel that you can grow loans and be able to more than offset margin compression, given the competitive environment and paydowns, while still maintaining pricing discipline?

Well, I think it's out there, Kevin. When we look at what's coming through our -- what we call early stage pipeline, where we get to share ideas as to how we think First Merchants' capital gets deployed inside of our customers, we put a price on it that we think is fair. And obviously, we don't win all of those. Mark mentioned just a moment ago that historically, our loan growth has been higher than our organic deposit growth, and for the most part, that's true. The last 12 months might be a little bit different than that because we were taking advantage without an acquisition through 2018 and trying to make sure we fortified our funding.And so we did go into some institutional deposits that were expensive relative to our core funding cost. Now with the addition of Monroe, the funding cost, the resultant loan-to-deposit ratio that Mark cited at 85%, it just allows us to really apply our best market knowledge on incremental credit and incremental funding. Did that answer your question?

No, that's perfect. I'm just curious where are you in terms of deposit pricing in your market. Are you mid-market? Are you at the higher end or the lower end currently?

Well, I got to tell you, it differs a little bit market to market. In Ohio, we've been on the aggressive side from a funding cost because our presence there is newer than it is through large parts of our company. And our most mature markets where we have the greatest pricing power, whether that's our headquarters in Muncie, the newest market in Monroe, we're definitely moving away from CD-led pricing. We're trying to keep our attraction points in the money market categories, but trying to be market smart about everything else. If you're asking me, are we high, middle or low, I would say we're in the middle. We're trying to lead the declines down based on the markets where we have pricing power.

And then lastly, how should we think about credit, provisioning and credit costs going forward?

Kevin, this is John. And I would say that what we've been doing kind of historically about that $600,000 to $1 million has been kind of our run rate. I think we've said historically about $1 million to $1.2 million, but we've been running the last several quarters less than that. So our provision expense, that's what I would use, say $600,000 to $1 million. The other thing, too, is with CECL into next year, things are going to change. So that may have an impact on what you model.

Our next question will come from Damon DelMonte of KBW.

Just a kind of follow-up on that last question regarding CECL. Have you guys finalized your expectations for the increase to the loan-loss reserve?

The third, what we've done thus far, Damon, is we've gone through an exercise of acquiring the software. We've built our models. We're conducting at this point parallel runs. And really into the fourth quarter, we're working with the third-party to validate our model. So really any adjustments to the models as a result of the valuators are going to happen in the fourth quarter and really be able to give you more clarity into January of next year.At this point, I really don't have a number other than to know that with the acquisition of Monroe, there's going to be a $1.4 billion in purchase loan. So that are included in the allowance calculation under CECL. That is not incurred, excuse me, included in the incurred loss method today. So we know that the allowance under CECL obviously will increase. It's about as much clarity, I think, that I can give you at this point.

And then last question, Mike, I think you mentioned that your utilization rates on C&I loans were down, like, 2% this quarter. Any color on what maybe was the reason for that? Are there any concerns from your borrowers that you're hearing anecdotally about trends in the economy? Any concerns about other prolonged impacts from the trade war or slowdown in manufacturing? Anything you could provide on that?

Damon, it's all anecdotal when it gets to me. And I'm talking about nearly $2.2 billion aggregation of C&I lines, right in between $2.1 billion and $2.2 billion. And so when it goes down 2%, I don't really get great clarity around it. If there's anything that I hear is that people need employees. And so they are top lines of our clients would probably be growing if we had more talent for them to access. Cash flows are strong. And so they've just been a relying on us a little bit less for working capital.

Okay. So no kind of impacts from the, in the manufacturing sector. I know there's been some data points that haven't been as strong as they have in the past?

No. I mean, we're a logistics center in the crossroads in America out here in the state of Indiana, and so we have a lot of transportation-related industries. That has, if you read, tractor trailer sales have softened a little bit, but the commitment, when I mentioned the denominator for the utilization between $2.1 billion and $2.2 billion, that's growing. So our C&I commitments actually grew $110 million through the quarter. The utilization overall is down.

Yeah. Okay, that's helpful. I saw that I had everything else was asked and answered. Thank you.

Thank you.

The next question will come from Brian Martin of Janney Montgomery. Please go ahead.

Hey, good afternoon, guys.

Hello, Brian. How you doing?

Good. Thanks. So just a couple for me, guys. Just Mark, go back to buyback for a minute. I know you said you're optimistic that you can continue to do some. I guess, do you intend to use the full authorization? Or is that kind of subject to the pricing, as you mentioned?

We intend to use the full $75 million. There's just been enough price volatility that we're trying to take advantage of some of the low points.

Got you. Okay. It helped from modeling perspective. Okay. And then just your comment on your FDIC assessment. So 0 in 4Q and then, I guess, can you give -- I guess, does it go back to a higher level with the large organization? And just kind of any clarity on kind of where that -- how that shapes up?

Yes. It's been -- obviously, there is a lot of volatility. We were anticipating higher rates in 2020. And now with these assessment credits, it makes for a pretty dramatic change from '19 to '20. So we were at a $1.4 billion in the second quarter -- $1.4 million in the second quarter of expense. We -- because of the credits, it becomes $700,000 benefit to us in the third quarter. It should be flat in the fourth quarter and then increases next year to an annualized rate of $5.5 million. So the credits go away and then we have increased pricing. And so it's a big swing year-over-year.

Yes. Okay. Okay. Just want to make sure I'm clear on that. And that full annualized run rate begins in 2Q, is that how to think about that?

It should begin mostly -- really 1Q.

Okay. Perfect. That's helpful, Mark. And just the last 2 was just -- maybe one for Mike or whomever, just on kind of M&A. I know with Monroe closed and I know you're still integrating it. But just kind of what do you guys stand on your outlook on M&A, I guess, are there discussions? Are they active? Are you more focused on at least in the short-term on getting Monroe integrated and getting the benefits realized out of that before you progress if there is something else that comes up?

No. I would think we would be ready to engage, should a great opportunity take place. So we're not in the middle of anything. We are focused on the integration. We are focused on getting off to a great start. As you know, it's been a protracted closing period in 2019, so we're kind of ready. I would say, the frequency of the conversation is kind of constantly -- it's kind a stable. There's always something taking place in the 3 or 4 or 5 state area that we pay a very close attention to. We're always feeling like we're having dialogues where they're well intended and a good use of each other's time. So we continue to believe in the power of scale and will be looking for franchise help when it's appropriate.

And would you say your outlook today, Mike, is getting over the $10 billion larger deals versus smaller or no preference at this point, just...

I think you have to move your targeting up a little bit for the magnitude of the effort that goes into it. And so if you think about the last handful of companies that have joined First Merchants, we've had a couple of smallish ones, well beneath $0.5 billion. I don't see those as being great fits for us at this point. But certainly, companies the size of Monroe or more sizable, we clearly feel like we have the capital for and the capability to executing that. So probably, to answer your question more simply, probably moving our appetite up a little bit.

And last one, Mark, was just on your commentary, I appreciate the commentary on the margin. Just if we assume there is, I know you initially talked about maybe being stable with no rate cut, but if you were to get 3 cuts in there, is it fair to just think about the cuts impacting as you go forward equal amounts and they wouldn't decline if you do assume three at maybe the next three meetings, you'd be looking to see the margins be 9 to 10, call it, 10 basis points lower than where it sits today on the core side?

Yes. I think that probably has, that has to be the case. We would see compression given our asset-sensitive position. And so if we, so 9 to 12 basis points.

And do you, remind me, do you guys have floors on the loan portfolio? Or is it a small portion?

Not, not really.

No. We really don't. Pretty close to zero.

This concludes our question-and-answer session. I would like to turn the conference back over to Michael Rechin for any closing remarks. Please go ahead, sir.

Thanks, Chuck. My only remark will be I appreciate people's attention to our results. Hope that if there is follow-up questions, you can get them to us, but appreciate the attention, and look forward to talking to you at the end of the, following the end of the year, talk to you then.

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