Good day, and welcome to the First Merchants’ Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] This presentation contains forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act. Such forward-looking statements can often be identified by the use of words like believes, expects or may, and include statements relating to First Merchants’ business plan, growth strategies, loan and investment portfolio, asset quality, risks and future costs. These statements are subject to significant uncertainties that may cause results to differ materially from those set forth in such statements, including changes in economic and business conditions; the ability of First Merchants to integrate recent acquisitions, changes in regulations and requirements of the company’s regulators; legislation changes in the creditworthiness of customers, fluctuations and market rates of interest and other risks and factors identified in First Merchants’ filings with the Securities and Exchange Commission. First Merchants undertakes no obligation to update any forward-looking statement, whether written or oral, relating to the matters discussed in this presentation or press release. In addition, the company’s past results of operations do not necessarily indicate its anticipated future results. Please note this event is being recorded. I would now like to turn the conference over to Mike Rechin, President and CEO. Please go ahead.

Thank you, Emily. And welcome everyone to our earnings conference call and webcast for the third quarter ending September 30, 2020. I’m joined this afternoon by several of our executives, specifically Mark Hardwick, our Chief Financial Officer and Chief Operating Officer, and soon to be Chief Executive Officer; John Martin, our Chief Credit Officer; also joining us today is Michele Kawiecki, our Director of Finance and soon to be Chief Financial Officer effective January 1; Mike Stewart, our Chief Banking Officer and soon to be President of this company also with us in the event that he can add thoughts or that may come out through questions later in the presentation. Given the unusual year and rapidly changing environment, our goal is to provide a thorough review of our third quarter’s results coupled with an eye towards 2021 as our planning matures looking for our opportunity next year. We released our earnings and a press release this morning at approximately 8:00 A.M Eastern Time and our presentation speaks to material from that release. The directions that point to the webcast are also contained at the backend of the release and my next thoughts will start from Page 5 – 4 a slide titled third quarter 2020 highlights. First Merchants has reported third quarter 2020 net income of $36.2 million, compared to the $36.8 million during the same period in 2019. Earnings per share for the period totaled $0.67 per share, compared to the third quarter of 2019 result of $0.71 per share. Also at the top of Slide 4 is reference to our pretax pre-provision income of $54.4 million and a resultant 1.59% return on assets. The quarter featured a stabilization of our core net interest margin that speak – Mark will speak due here shortly, as well as strengthen…

Thanks, Mike. My comments will begin on Slide 8. Our total assets on line seven increased by $1.3 billion, or 13.7% annualized since year-end 2019; investments on line one increased by $337 million or an annualized 17.3%, following a strong 2019, where investments increased by 59% over 2018. Loans on line two have increased $779 million since year end of the increase PPP loans net of deferred loan fees and cost accounted for $901 million of the growth. And you can see that number highlighted in footnote one. Additionally, on line three, the allowance loan losses increased by $47 million or 59% year-to-date, primarily due to COVID-19 related economic challenges. The composition of our $9.3 billion loan portfolio shown on the upper right hand side of Slide 9 produced a third quarter 2020 yield of 3.93% down from the second quarter of 2020 yield of 4.10% despite the link quarterly decline in overall loan yields of 17 basis points. our net interest margin; which I’ll speak to in a moment, stabilized materially this quarter. Also of note, PPP loans negatively impacted loan yields by 12 basis points this quarter and 9 basis points in the second quarter of 2020. So, our normalized loan yield for the quarter was 4.05% versus the 3.93%. On Slide 10, as of September 30, 2020, our $2.9 billion investment portfolio produced a 2.94% yield with an unrealized gain of $141.5 million. We anticipate expanding our commitment to the tax-exempt municipal sector, which currently stands at 56% of the portfolio. our quarterly gains highlighted on the right side of the page. Our – a result of opportunistic sector migration and duration management. This active management along with the sector allocation decisions other reason that our yields are about 70 basis points better than our peer group…

Thanks, Mark. My comments will begin on Slide 21. Looking at the top right of this slide, you’ll see that we continue to build our reserves although more modestly than we did last quarter, we have the beginning allowance balance at the end of Q2 of $121.1 million less net charge-offs of $6.9 million, which John Martin will talk a little bit more about plus the Q3 provision expense of $12.5 million, which brings us to the September 13 allowance for loan loss balance of $126.7 million. I will remind you that we elected to defer the adoption of CECL. So, we calculated the provision using the incurred loss method, but continued to run our CECL models parallel and we’ll be implementing the CECL methodology next quarter. Moving down to line nine, the remaining fair value marks on purchase loans totaled $26 million adding those marks to the allowance balance, totals $152.7 million, which is 1.65% of total loans, which Mike mentioned earlier in his remarks. On Slide 22, this is a slide that we added last quarter, which is intended to show you that when considering our robust capital and allowance for loan loss levels that we have more than $500 million in reserves to cushion us through the economic downturn. The table at the top shows a roll forward of the allowance for loan loss since last quarter. The first highlighted line shows our current allowance balance of $126.7 million with an allowance to loans ratio of 1.37%. When excluding the PPP loans from total loans, the allowance to loans is 1.52%. And as I said earlier, we did not adopt CECL, but in our 12/31/19 Form 10-K, we disclosed that the estimated CECL Day 1 adoption, if we had adopted on January 1, was estimated to increase…

All right. Thanks, Michele and good afternoon. I’ll begin my comments on slide 24 by reviewing a loan portfolio, provide an update on modifications, discussed the COVID sensitive portfolios, review third quarter asset quality, then touch on the PPP loan program before [indiscernible] providing some closing remarks. So, turning to slide 24, the portfolio was mostly unchanged with reductions in C&I and construction lending on lines one and four, offset somewhat with increases in sponsor finance and owner occupied C&I related commercial real estate, with an overall net decrease on line 14 of $52 million. then turning to slide 25 and contributing to a portion of the decrease in C&I commercial loan balances was the lower line utilization, which attributed to $46 million and decreased commercial line of credit outstandings. Despite the lower outstandings, we continue to book new commitments as shown by the blue bars in the same graph, with commitments increasing $60 million, as well as an overall growth and pipeline activity that Mike Rechin will discuss in his remarks. Moving to the right portion of the slide, COVID modifications still in deferral have fallen to $176 million, or roughly 2% of loans, down from a high of $1.1 billion first modifications last quarter, or roughly 12% of loans. We continue to work with affected borrowers through the latitude granted in the CARES Act. And I’ll talk more about some of those efforts as I discussed the slides related to COVID-sensitive industries. Turning to slide 26, when we break out the industries most impacted by the pandemic, hotels and hospitalities have, and continue to be the sector, where the most significant amount and number of modifications were granted with some lesser amount in manufacturing and wholesale trade. Please turn to slide 27. We’re out focused for a moment…

Hey, thanks, john. I had a little bit more material to cover. Before I do that, I wanted to add a couple of different perspectives to some of the perspective that mark might have shared earlier or john. mark in particular, in highlighting some of the non-interest income categories spoke to dollars, right out of the financial statement, that’s the intent. What’s behind that is an increasing activity or an increasing engagement of our customers in the economy. I feel like there’s an advantage that accrues to our company by being in states, where the economy is getting into legs more quickly than other parts of the country. And so for instance, debit card activity, which reached its floor in the march-April time period at about just over 16 transactions per card, rallies to September, early October level of 2021 transactions per card, 26% or 27% up, included in kind of the dollar synopsis that mark provided. commercial transactions for a commercial bank show similar levels of recovering engagement, remote deposit volume of 6% in that same march to September time period, I used a moment ago. Wire activity up 22%, ACH volume up 6% in units, 17% in dollars. Reasons to look forward and follow Mark’s commentary about the service charge line item likely to reach its prior levels. John referenced the pipeline and pretty unusual for our company to have a quarter with absent organic growth, typically about 1% to 2% per quarter, 8%-ish on an annualized basis, oftentimes higher. So that’s unusual. And yet, we follow the lead of our clients. It’s also unusual to book $900 million on the loans in a 45-day period on a base of $9 billion in the time period immediately prior to that. So, we’re learning as we go and I…

[Operator Instructions] The first question comes from Scott Siefers at Piper Sandler. Please go ahead.

Good afternoon, guys.

Hey, Scott.

Hey, congratulations, everybody. Lots of change going on there. I think first question, Mike, you sort of alluded to in your closing comments, the pace of loan growth, sort of a little unusual for you guys. From the outside, it can be a little tough to tell what’s going on even industry wide, the bigger banks are seeing loan contraction. Some of the smaller banks still kind of holding their own and you guys are sort of in a little bit of a middle ground. So maybe, just some color on exactly how your customers are thinking about things what loan demand looks like and where you might see it going over the coming couple of quarters.

I’m glad you came back to that, because I had my pipeline statistics right in front of me. And while I got hung up on some of the fee-driven pipelines and levels, I’ve skipped that one. So, I appreciate you bringing it back to me. Well, let’s break it up into parts. Well, let’s talk attitudinally. So, Mike Stewart’s here, he might have an ad, but our customers are wary. They’re looking at the same set of uncertainty as we are and yet, they’re opportunistic. And so in john Martin statistics, he talked to you about a pretty healthy level of originations. And so our last quarter originations are a great, our utilization way down about 10% over the last two quarters. I think it’s 42% down from 50% over the last couple quarters, Scott. we talked about my comment – I’m going to come back to the C&I part in the real estate partner seconds, but relative to mortgage is just really, really strong like most mortgage participating banks are – and yet, ours might be even a tad stronger than that I was looking at, there’s obviously a seasonal dip, typically, right when you get to the holidays at the latest part of the calendar year, but going into the fourth quarter, our pipeline was even higher than it was in the third quarter. So, it’s a rate-driven business, that’s good and our execution has been great. So, mortgage is going to continue strong. And strategically maybe, some more, that’ll wind up on our balance sheet versus the originating sell model, which is dominated on mortgage business for years. On kind of the more rubber meets the road business to include our specialty businesses, municipal and sponsor, the regaining steam, they’re not as – they’re not where they were four quarters ago. and yet, I’m looking right here, I’ll just – I’ll just quantify it for it commercially, we’re up to $600 million from $440 million going into the last quarter. So, I would just caution the idea that number, which we’ve historically shared, would incorporate all of our construction commitments and so draws against those are uneven, and it obviously can’t speak to what our existing clients do with utilization going forward. But in terms of origination pipeline commercially, it’s up 100 and more – a little bit more than $150 million, from where we started the last quarter. We view that positively. Does that help with what you’re looking for?

It does, it does, Mike. Thank you very much.

You’re welcome.

And maybe, next question is for you. So, the $52.2 million CECL impact, I understand that sort of at this point, illustrative based on range you had given previously. But with that occurring in the fourth quarter, will the adjustment to the reserve run through the income statement, or will that run through below the line the way they did that it did for the other institutions that had adopted earlier this year?

Well, the $52.2 million will go through equity. But then any catch up that we have, which we really don’t I mean, I think we’re in our fourth quarter; we’ll be looking at our provision using the CECL model. And that provision, whatever adjustment we have in the fourth quarter will come through the income statement.

Okay. So okay, so the $52.2 million would go through equity, but then any additional sort of, I guess, COVID catch up would go through the provision. is that a fair characterization?

It is, I think the way that we have viewed our provision. As you know, I mean, we’ve build fairly aggressively through the last three quarters and had been running our models parallel. And so I think in q4, right now, I would expect we would have some reserve bill, how much? I’m not sure, we’ll have to look at our forecast, look at our loan growth, credit quality, et cetera. But I don’t expect it to be as aggressive as it was in the first two quarters.

Okay, perfect. And so that that actually went to the heart of my sort of final provision related question. I mean, you guys, as I recall the commentary in the last couple of quarters, even though you’ve been incurred loss methodology, you’ve been sort of providing at a level that would have equated to what you would have done in a CECL world, right? So, there shouldn’t really be that much of a real catch up, right?

That’s correct.

Okay. All right. Perfect. All right. Thank you guys very much.

Thanks, Scott.

Our next question comes from Terry McEvoy from Stephens. Please go ahead.

Hi, thanks. Good afternoon. Maybe, just more of a bigger picture question to start. How are you thinking about the branch footprint today, quite a few peer banks have talked about some branch consolidation and a benefit to the expense line. And so I get as you look out into next year, what are your thoughts on that topic?

And Terry, it’s Mike, I’ll start with that and then mark might have a comment. but it’s a every year part of our planning process. And when you look historically at us, we’ve been optimizing our storefront census for years. We’re probably down 40 stores in the last five or six years. We’re looking at it again; obviously. We did a great job of helping our clients use our digital technology. And clearly, the lobbies were closed for some period of time. And so that’s going to have an impact on our cost. I know you’re trying to get to a more specific answer. We’re going to have banking center closures in our 2021 plan. We’re trying to size that right now, both in number of locations and the expense component, as we also assess the investment we’re going to be making in our digital technologies.

Thanks. And then as a follow-up question, maybe, it’s a little too aggressive on the Durbin impact in the card payment fees. Can you maybe, talk about the fourth quarter, Mike; I know you talked about growth rates and some of the businesses that drive the revenue there? But could you maybe help us out in terms of the fourth quarter? What type of pickup those growth rates could be off the new kind of base of $4 million per quarter?

Are you speaking directly to – I got you, the card payment fees in Durbin.

Yes.

Yes. I did think the $4 million kind of establishes a new baseline or lower bounds. We do see some pickups and card payment fees, as Mike mentioned and we should see, you know, kind of a mid single digit growth rate going forward. But yes, the third quarter, I think the key to that is we recognized all of the Durbin impact in this quarter. And there, there won’t be kind of a second or an additional decrease from here. So, it’s all just about card payment activities and the growth in that line of business.

Great. Thanks, everyone. And John, thanks for all the additional data in your slides. Much appreciated. Thank you.

You’re welcome.

Thanks, Terry.

Thanks.

Our next question comes from Daniel Tamayo and he comes from Raymond James. please go ahead.

Hi, good afternoon, everyone and I’ll echo congratulations on all the promotions and Mike on your retirement.

Thanks, Daniel.

Sure. Starting on the on the margin, I just wanted to make sure that I’m reading your comments correctly here. When you say, you think the NIM should be at a – core NIM should be at a predictable level going forward carrying into 2021 you’re essentially saying stability is what you’re looking for there. is that correct?

It is, yes. We’re still working the cost side, aggressively. we’re still working the kind of renewal and new origination side aggressively on the lending side or on the asset side, looking closely at the bond portfolio with the objective of maintaining or increasing the margin from here. And now there’s pressure given the yield curve, but that’s our focus.

And does that assume – does that assume like when you get into 2021, like an 8%, organic loan growth that Mike was talking about or something shorter than that?

Yes. Traditionally, we talk about growing at mid-to-high single-digit growth rates, maintaining a 50%, approximately a 50% efficiency ratio, which we believe allows us to trade at a high performance level, which then kind of opens the door for M&A opportunities. And so I still think we’ll be at the mid-to-high single-digit growth right next year, despite what this year 2020 has been more challenging than normal.

This is Mike, again, if you extrapolate a continued growth of commitments. That obviously speaks well for our balance sheet going forward. At some point that utilization and I applaud our clients for being smart about turning receivables into cash and paying down their lines and the near term that hurts our net interest income. In the next term – short-term perhaps certainly new medium term, their historical usages ought to bear out. And when you couple that with our market coverage, yes, I think getting back to post-COVID 8% annualized is absolutely the plan.

Perfect. And then on the deposit side, how do you feel about the kind of the increase in deposits you’ve seen if you think some of that will run off with the PPP funds, or do you think there are going to be stickier than maybe, you were thinking previously?

Yes. If you look at last year’s growth rate of $2.1 billion, in a little over $1.1 billion related to acquisitions. It was still a really strong organic year, this year at $1.1 billion with $900 million of PPP loans. Now, it’s a strong organic year, plus PPP. And the real question will just be as these PPP loans are forgiven how much of those deposits stick. Today, we feel like it’s a large percentage, I would have – I think, last quarter, I mentioned we thought it was about half our confidence level and that is increasing as we move through the remainder of the year. And so I have a hard time ever suggesting that deposits are going to grow organically plus 10% on a regular basis, but we’ve been able to accomplish that last year. And again this year, I think we go get back to kind of the historical levels of mid-to-low single digits on organic deposit growth in the future. And certainly, there can be situations or opportunities, where we can increase that level. But it’s the reason we think of growing loans, mid-to-high single digits, deposits at low-to-mid single digits and replacing the difference over time and that liquidity gap with M&A.

That’s really helpful. I appreciate it. I’ll step back. Thanks, guys.

Thank you.

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

Hey, good afternoon, everybody. And Mike, congrats on the retirement and congrats everybody else in their newly appointed roles.

Thanks, Damon.

Sure. The first question I had regarding capital in your outlook for that. given the level of where shares we’re trading and given the strong capital levels you have, what are your thoughts on buybacks at this point in time?

Well, we completed a buyback last year and we’ve felt like we’ve achieved pretty good execution in this environment with our shares where they are, we think it would be smart and opportunistic. We don’t currently have a plan approved, but continuing discussions at the board level.

Okay. And how about with regards to dividends? I think you noted that the payout is still less than 50%, would you consider increasing the dividend?

Yes. We would definitely consider increasing the dividend. We just decided in this environment with some economic uncertainty. We’ve decided to leave it at $0.26 this year. But when we would likely make a move and May of next year, which would be our traditional second quarter decision.

Okay. And then I guess, with regard to the PPP forgiveness process, you noted that there was some submissions already in the fourth quarter. Do you expect to have this done by the end of 2021 or maybe more so in the first half or the back half, like how do you see the cadence of the forgiveness process?

Yes. So, the way I kind of look at it as we started in on the largest names, those greater than $50,000. So, I suspect what’ll happen is it’ll probably be more frontend loaded to the year than it is backend loaded to the year with the ones less than 50,000 by number kind of submitted once we get that process from our software vendor up and running, but the dollar should – I would expect be more frontend loaded to next year.

Got it. Okay, that’s all that I had. All my other questions were asked and answered. Thank you.

Thanks, Damon.

[Operator Instructions] Our next question comes from Brian Martin at Janney Montgomery. Please go ahead.

Hey, good afternoon and congratulations, everyone.

Thank you.

Thanks, Brian.

Hey, just one question. One easy one for John. I mean, you guys talked length about and thank you for all the credit details, John. Just – were there any changes or in the special mentioned credits this quarter? I know you called out the classifieds, but any changes on that front of material note?

What I would say is that there’s probably some have the actual criticized or special mentioned numbers in front of me. But what I’d say is there has been an increase in special mentioned that being the transitional greed, traditionally – traditional greed category. And as we move things into that category, we wait to see how the pandemic’s is going to affect our borrowers. And if it gets bad enough, we move them down to substandard, if not; we’ll move them back up to pass again. So, there has been some migration into that category.

Okay. If I look at the similar levels like the classifieds or maybe a little bit more than what was gone into classifieds?

It will be incrementally more just because of the nature, you move those, we have more move into special mention, right. And then some are going to move down to substandard and then some will move back up into pass.

Got you. Okay. Thanks, John. And maybe, just one for whoever on the capital question. Just you talked about the dividends in the buyback? How about your appetite today or willingness to look at M&A today? Or just discussions? How those are playing out if anything?

I think there’s been a benefit to this environment that while it hasn’t been heavy, in what I would consider to be Brian, genuine M&A discussions, there’s been more of bank-to-bank dialogue about all the uniqueness of this year than I can ever remember. So, Mark and I have always kind of led to discussions with other banking companies and that will clearly continue under Mark’s leadership, because we think we’re very good at it and we think there are companies that when paired with us would make for a more powerful banking company. So, our refreshed executive team have a keen eye for not only the organic strategy of this business, but opportunistic acquisition as well, in any business, we’ve – it doesn’t have to be limited to full banking companies.

Do you feel like you need a little bit more clarity on the pandemic, Mike, before you engage in something or I guess it – I guess that was really kind of that it’s...

I would say yes, I mean, you heard John’s answer a moment ago about the transitional nature of some of these clients working through this period, I feel like every bank is doing the same thing. So, the answer would be yes, we’d love to have a little bit more settling before you go acquiring a bunch of loans you didn’t originate.

Yes. Got you. Okay, that’s helpful. And just the last one for me was just on the – as you guys look at kind of your comments about the budget, Mike and kind of stepping into next year. Would your expectation be, as you talked about the branch cuts that maybe, you can hold on to the efficiency, where it’s at today, even in a – even in the low rate environment? Or how are you thinking about just kind of the efficiency as you go into next year in the budgeting process?

Yes. I think the acceptability of a budget for us, both at the senior management level and at the Board level is going to call for it to have a look alike, efficiency, absent any game changing technology investments we make. But no, it’s I think our stripes around that topic of efficiency are going to remain the same.

Yes. Okay. Perfect. That’s all I had, guys. Thanks.

Thanks, Brian.

Thanks, Brian.

Next, we have a follow up question from Scott Siefers from Piper Sandler. Please go ahead.

Hey, thanks, guys. A couple related to credit. So, I guess, Michele, just in looking at what the reserves will look like post-CECL, if we are in that kind of 2%-ish range, and that’s going to compare very, very well, relative to a number of your peers. It’s just curious that I’m not thinking behind the need for even modest additional reserve bill, is that just kind of an abundance of caution given the uncertainty or any color there. And then as the follow-up to that, John, none of us really knows where this credit cycle is going to go. But losses have stayed very low, I think for longer than most of us would have thought as all the stimulus works through. So, this quarter absent the single credit that you talked about, it looks like charge-offs would have been pretty negligible. I guess I’m just curious as to your sense for the evolution of last migration in the cycle, when will things pick up more materially?

You want to go first, Michele?

Sure. I’ll go first. Yes. Scott, I mean, I think you just nailed it. It really is an abundance of caution. I mean, you’ve heard John talk about our credit portfolio. There isn’t anything in our credit portfolio that is spooking us to think that we need a large reserve. We, just like anybody else, don’t know exactly what the depth of this is the impact is going to be on our customers nor when you know the loss emergence periods will really emerge, but we want to be ready and we feel like having an abundance of reserves is a good place to be. It’s a place of safety.

Yes. Okay. Thank you.

Yes. And then Scott, just with respect to your question, built into some of the reserve building in the first two quarters were specific reserves. So, when you look at and you think about what happened in that second quarter, a part of what we charged off in this quarter was put in there in that quarter in the second quarter. And so when you look forward to quarters and you look for I’ll say, loss emergence out of some of these names that have specific reserves in it, and you look at that line, you can kind of see now, I would say for the $14.1 million loan that we just put in the non-accrual, it’s got a $3.1 million or a little bit grab – was a little over $3 million specific reserve on it. So, that’ll eventually charge out. But beyond that, the specific reserves tail off pretty significantly there. So, having visibility into the future, on a name-by-name level, or at a name-by-name level, there isn’t a lot that I see today and to track it beyond that. It’s really just in my view, to look at, where are the classified assets going? And directionally, what does that tell you about potential future losses. And that helps you, but that’s kind of how I think about it.

All right. thank you very much.

Thank you, Scott.

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

Thank you, Emily. I really don’t have any. I appreciate the quality of the listening to the First Merchants’ story. As we can tell, we’re looking forward to finishing strong in 2020 and getting off to a fast start with our leadership team here next year and look forward to talk to you in a couple of months. Thank you.

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