Thank you for standing by, and welcome to the First Merchants Corporation's Fourth Quarter 2023 Earnings Conference Call. Before we begin, management would like to remind you that today's call contains forward-looking statements with respect to the future performance and financial condition of First Merchants Corporation that involve risks and uncertainties. Further information is contained within the press release, which we encourage you to review. Additionally, management would refer to non-GAAP measurements, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. The press release available on the website contains financial and/or other quantitative information to be discussed today as well as reconciliation of GAAP to non-GAAP measures. As a reminder, today's call is being recorded. I will now turn the conference over to Mr. Mark Hardwick, Chief Executive Officer. Mr. Hardwick, you may begin.

Good morning, and welcome to the First Merchants' full year 2023 conference call. Thanks for the introduction and for covering the forward-looking statement on Page 2. We released our earnings today at approximately 8:00 AM Eastern and you can access today's slides by following the link on the third page of our earnings release. On Page 3 of our slides, you will see today's presenters and our bios to include Mike -- our President, Mike Stewart; Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki. On Page 4, we have a few highlights of the year to include final total assets of $18.3 billion, $12.5 billion of total loans, $14.8 billion of total deposits, and $7.3 billion of assets under advisement. On Slide 5, if you look at the bullet points under our fourth quarter results, we grew loans during the quarter by 6.6% annualized with a new and renewed loan yield of 8.01%. We also increased deposits by 4.8% during the same period and we reported Q4 2023 EPS of $0.71 per share, or $0.81 -- or $0.87 when adjusted for several one-time expense items incurred during the quarter. Those items include $12.7 million in one-time charges that include the FDIC special assessment due to several bank failures in March of '23, severance expense related to a voluntary early retirement incentive plan that we offered to employees in the fourth quarter of 2023, and the write-off of a lease agreement due to our Indianapolis regional headquarter move. Moving down to the bottom half of the page, you will see year-to-date bullet points. We've delivered net income of $221.9 million and produced $3.73 of earnings per share for the year when adjusted for the same one-time expenditures that EPS totaled $3.8 -- $3.89. During a year where safety and soundness became the highest priority of stakeholders, we effectively repositioned our balance sheet to prioritize cash, liquidity and capital. The company's liquidity position improved by $585 million as cash increased $300 million and borrowings declined $285 million. Our tangible common equity increased by $222 million, during the year, driving our TCE ratio up from 7.37% one year ago to 8.44% at year-end. We maintain strong credit quality and top decile allowance for loan losses totaling 1.64%. I'm proud of our team of driven, collaborative and high character employees for rising to the call to deliver an enhanced and resilient balance sheet while also adding high quality risk aware loans at a clip of just over 5%, and for delivering net deposit growth of 3% for the year. Before handing over the presentation, I would just like to thank our 2,000 plus colleagues for tackling a turbulent 2023 head on and for delivering top quartile results that we can all be proud of. Mike?

Yeah. Thank you, Mark, and good morning to all. Our business strategy that is outlined on Slide 6 remains unchanged and is a reminder that the financial results we deliver represent the durability of our business model within the primary markets of Indiana, Michigan and Ohio. We serve diverse locations in both stable rural markets and in growing metro markets. We are a commercially focused organization across all these business segments and collectively the First Merchants team is actively engaged in all of our communities, delivering the solutions listed on this page. Throughout 2023, we have remained committed to our business strategy of organic growth of loans, deposits and fee income, attracting, retaining and building our team investing in technology platforms that enhance the client experience and delivering top-tier financial metrics. Let's turn to Slide 7. This slide validates our ability to deliver organic growth of both loans and deposits. The annualized total loan growth for the fourth quarter was 6.6%, highlighted by the 8% growth in commercial portfolio. During our last quarter call, I noted the strong commercial pipeline and that pipeline did materialize from our C&I focused regional bankers and from our investment real estate team. John has more detail to share around the portfolio mix and his detailed analysis show that nearly 70% of our total loan growth of 2023 comes from the commercial segment, which is consistent with our global portfolio mix of 75% commercial and the rest consumer. Within the consumer portfolio, we have residential mortgage, HELOC, installment and private banking relationships, and during the fourth quarter that portfolio grew at a 2.7% annualized rate. So again, for 2023, the total loan portfolio grew at 5.1%. Mid to high-single digit loan growth is the expectation moving forward in the 2024. While the commercial loan pipeline…

Slide 8 covers (ph) our fourth quarter results. On line one you will see we grew assets by $313 million during the quarter, representing a very productive quarter for the company. $203 million was from loans which Mike just covered, and $98 million was an increase in investments reflecting an increase in value of available-for-sale securities. Deposits on line four grew $175 million leading to strong equity growth of $155 million, which you can see on line five. Pre-tax pre-provision earnings, when adjusted for the one-time charges Mark described of $12.7 million, totaled $61.1 million for the quarter. Adjusted pre-tax pre-provision return on assets was 1.33% and adjusted pre-tax pre-provision return on equity was 11.47%, all of which continue to reflect strong profitability metrics. Tangible book value per share increased 11.7% from last quarter, totaling $25.06 at year end. Slide 9 shows the year-to-date results. The variances on balance sheet lines one through five display the work the team has done in shifting the earning asset mix through the year, which resulted in a robust increase in yield on earning assets of 1.46% year-over-year. Year-to-date, pre-tax pre-provision earnings, excluding the one-time charges, I mentioned previously, totaled $275.4 million. Adjusted pre-tax pre-provision return on assets was 1.51% and adjusted pre-tax pre-provision return on equity was 12.95%. Tangible book value per share increased $3.61, or 17% over prior year reflecting strong year-to-date earnings. Excluding the noise from mark-to-market adjustments on the securities, the company has experienced tangible book value growth every year for the last 10 years, and we are pleased to deliver another year of growth in 2023. A graph of this is included on Slide 23. Details of our investment portfolio are disclosed on Slide 10. We sold $43 million in bonds this quarter, resulting in a loss of $2.3…

Thanks, Michele, and good morning. My remarks start on Slide 18. I'll highlight the loan portfolio, touch on the updated insight slide, review asset quality and the non-performing asset roll forward before turning the call back over to Mark. Turning to Slide 18, on line two, where I highlight the various portfolio segments, commercial industrial loans, originated by our regional and middle market banking teams, grew the portfolio by $214 million. We came off a strong backlog in the third quarter as Mike mentioned, with good pull through. Investment real estate, on line five, also had good movement in the quarter from both new originations and with properties moving out of the construction portfolio and to mini-perm. As the sponsor portfolio seasons, we continue to see exits from the portfolio as firms reach their time horizon, resulting in periodic exits and paydowns. As mentioned on prior calls, higher interest rates have driven additional capital investment into platform companies in order to meet our underwriting and stress criteria. Turning to Slide 19, I've updated the portfolio insights slide to provide additional transparency. In the commercial space, the C&I classification includes sponsor finance as well as owner occupied CRE associated with the business. Our C&I portfolio has a 20% concentration in manufacturing. Our current line utilization has remained fairly consistent at around 41% with line commitments increasing roughly $89 million for the quarter. We participate in roughly $740 million of shared national credits across various industries. These are generally relationships where we have access to management and revenue opportunities beyond the credit exposure. In the sponsor finance portfolio, I've highlighted key credit portfolio metrics. There are 86 platform companies with 53 active sponsors in an assortment of industries, roughly 65% have a fixed charge coverage ratio of 1.5 times based on September…

Turning to Slide 23, I'm going to review a few of my favorite charts as they take a more long-term perspective. Look at our performance. On the top right, our 10-year earnings per share CAGR totaled 10.2%. And looking at both the growth and tangible book value per share and dividends paid during 2023, total book value return equaled 23% or if you prefer to look at tangible book value per share excluding AOCI, our total book value excluding AOCI return for the year equaled just over 15%. Slide 24 represents our total asset CAGR of 12.9% during the last 10 years and highlights meaningful acquisitions that have materially added to our demographic footprint that fuels our growth. Slide 25, I've made a few edits to include replacing the word digital transformation with continued investment in. During the last three years, we have delivered a new online account origination platform, enhancements to our commercial loan automation system, and we are just days and months away from completing four big enhancements. This week, we completed the rollout of our personal in branch account opening process, which reduces account opening times from an average of 45 minutes to less than 10 minutes while eliminating error rates by nearly 75%. It's also connected with our online account opening process that can be delivered seamlessly through either channel or both channels. We're also live or in beta with our new online and mobile platform for consumer -- customers and plan to be fully live with 160,000 customers by the end of February. The first half of 2024 also includes the completion of our new wire platform, our new online platform for commercial or treasury management customers, and upgrading the private wealth platform. I should also remind all of you that we have a handful of one-time expenses related to temporarily overlapping systems and customer service center augmentation to handle these upgrades. We expect a first quarter charge of approximately $3 million and a second quarter charge of approximately $2 million. Through these projects, we have truly streamlined and simplified the client experience, and we will continue to focus on modest, relevant enhancements in the future. Thanks for your attention and your investment in First Merchants. And at this time, we're happy to take questions.

Thank you. [Operator Instructions] Your first question our first question comes from the line of Daniel Tamayo with Raymond James. Your line is now open.

Hey. Good morning. Thanks for taking my question. Excuse me. Maybe Michele, just first on the margin and the NII outlook. I appreciate all the detail you gave on the funding side as well as the asset side repricing. And I apologize if I missed it. But did you have kind of a baseline assumption for how the NIM trends through 2024 and what NII might look like?

Sure. Good morning. So for Q1, we do expect to see a bit more compression in 2024. Our December margin was 312. So that can give you a bit of a data point. And then I would also remind you that because we're so commercially oriented, margin is always seasonally low in Q1, simply due to day count. So just another item. But assuming a flat rate environment, we are expecting margin to stabilize in the quarters thereafter. Now, if there are rate cuts, our model tells us that for each 25 basis point rate cut, margin declines about 4 basis points. We're taking a very proactive approach in managing our deposit costs down in anticipation of the rate cuts, which could perhaps lessen that impact and a couple of other items. We'll be paying down about 40 million of sub debt at the end of this month that had a rate near 10%, which will offer some meaningful savings. We continue to sell bonds, which create some spread when we put that cash back to work and loans and higher cost funding. And the other thing that I'd mentioned too, is typically in a declining rate environment, we tend to see an opportunity for higher mortgage loan gain sales. So although we think that there are definitely some tail -- some headwinds when we have -- a declining rate environment, we think that there's some tailwinds as well.

I appreciate all that detail. Is there kind of an all-in NII outlook? You obviously have an expectation for continued strong loan growth in the year. Just curious how you think NII might end up for the year.

Yeah, I think in Q1, we will see some compression in net interest income, but then we're expecting stability and growth thereafter, particularly in the second half due to our expected growth.

Okay. Terrific. And then lastly, just following up on your comment on mortgage banking, you've maybe not bottomed as low as some other banks, doing quite well, actually, last year. Just curious where you think that number could end up once rates start coming down. I mean, you're -- I think you were doing about 20 million a year during some pretty good times in 2020 and 2021. Do you think you'll be able to get above that given the investments you've made?

Daniel, it's Mark Hardwick. I -- that's a good question. We-- we're really pleased by the enhancements we've made with the team post Level One. So we kind of doubled the size of the business before the downturn in rates. And when I say doubled our portfolio -- our -- First Merchants originations were almost identical to Level Ones. And so by putting the two organizations together, we feel like we've materially strengthened the outlook. And I do think it has a lot to do with rates. But I'm confident that we had potential and capacity in the core First Merchants franchise based on this change that we've had in our strategy around mortgage. So, yeah, I'm confident that if we have a decline in rates, that we should be able to exceed our historical performance, when you look at the two on a combined basis.

Terrific. Thanks for all the color. I'll step back.

Thank you.

Thanks, Danny.

One moment for our next question. Our next question comes from the line of Damon DelMonte with KBW. Your line is now open.

Hey. Good morning, everyone. Hope you're all doing well today. Just wanted to start off with some questions on expenses. Michele, looking for a little bit more guidance here as we go into '24. Obviously there are some one-time items this quarter, but kind of what are you thinking about for a good core run rate?

Yeah. Good morning, Damon. So this quarter, our core expense total when you back out those one-time costs was $95.4 million. So on a core basis, we expect the quarterly expense run rate to be flat to maybe up 2% on the high side in 2024 compared to this quarter. As Mark mentioned, we will incur some one-time charges on top of our core expense run rate in Q1 and Q2 due to the online banking conversion and our private wealth platform conversion of a few million dollars each quarter. But we will disclose that impact and make sure that that's transparent to you. But like I said, I think we're very focused on good expense management for 2024 and feel that -- strongly that we can achieve that.

Got it. Okay. That's helpful. Thank you. And then on the fee income side, you had called out a few items. If you kind of net those three items together, you're probably closer to like a $28 million operating non-interest income result this quarter. I know there's some volatility around potential for mortgage banking income that we just spoke about. But as you look at your other drivers of fee income, how should we kind of look at the quarterly level going forward?

Yeah. This quarter, I think, it's -- the total is a little light for a run rate in 2024. We're expecting it probably to average more around the 30 million to 31 million per quarter next year.

Got it. Okay. And then just lastly, obviously some good recapture on the AOCI, which boosted tangible book value and intangible common equity. I think the TC ratio ended around 8.5%. Just kind of wondering what your thoughts are on capital management and a buyback in particular.

Yeah. Thanks, Damon. Yeah. We were really thrilled to see the return to that TC ratio over 8%. And it was the catalyst to paying down $40 million of our sub debt. We decided to tackle it first. We've got a remaining $25 million, which we're likely to pay down next quarter. And just feel good about managing the bank based on a TC and total risk-based capital level, primarily off of common equity. So thinking about that first, there may be a time, assuming that we have stabilization in rates where we have the -- as we continue to add capital through earnings, we have the capacity to be active in the market. At these prices, I'm inclined to do that, but we have not started that process.

Got it. Okay. That's all that I had. Thanks a lot. Appreciate the color and commentary.

Great. Thanks, Damon.

Thank you. One moment for our next question. Our next question comes from the line of Terry McEvoy from Stephens. Your line is now open.

Thanks. Good morning, everyone.

Good morning, Terry.

Hi. The $214 million of C&I regional banking loans caught my eye, and I think there was some mention for prepared remarks about pipelines being healthy kind of starting the quarter. Any specific industries, markets that contributed to the outside growth last quarter? And what are your outlooks kind of specifically for the C&I business, which is a big part of the portfolio?

Yeah. Good question, Terry. It's Mike Stewart. You know, the muted growth that we saw the prior quarter was simply because a lot of the C&I transactions really hadn't closed at that point. So we ended the quarter with a really strong high pipeline that didn't materialize. I think John even pointed that out. And it really was through that whole region bank model, which is traditionally the commercial industrial space. And that's the space that I think that we still have good outlooks as we turn the year into 2024. Fully staffed in our marketplace, taking advantage of competitive disruption, strong economic factors, when you think about Michigan, Indiana, Ohio. So that's what's driving a stable pipeline of that. We saw some nice growth in the investment real estate portfolio, solid transactions. Some of it could be growth underneath construction draws, but more of its just the origination has been good in the asset classes that we are deploying in, in addition to some fully funded term loans that we focused on. So just a nice balance mixed across the Midwest here.

And Terry, I might just add, in terms of industry, it's pretty much across the board. I mean, we're a Midwest C&I bank or commercial bank, and when we pick up C&I, it's just what's in our footprint. It's not a vertical that we're in, any particular area. So it comes in kind of a broad base as to what it happens to be.

Thanks for that. And Michele, do you have the level of index deposits as we all attempt to potentially model out lower rates and how that could impact your funding costs?

Yeah. We have $2.5 billion of deposits that are tied to an index that we'll be able to reprice along with rate cuts if those occur.

And then just a last question is kind of the expenses, early retirement, severance lease. Are those connected to kind of broader expense management actions to manage expenses in 2024? And I'm trying to think of the -- their real numbers and how do you think about the earnback on the, call it, $8.4 million?

Yeah. The earnback is quick. It's less than a year. So we're really pleased with the way the voluntarily retirement played out. And as much as anything, just excited about the opportunity that it creates for hungry employees that are ready for the next stage of their career.

Great. Thanks again for taking my questions. Have a good day.

Thanks, Terry.

Thank you. One moment for our next questions. Our next question comes from the line of Nathan Race with Piper Sandler. Your line is now open.

Yeah. Hi, everyone.

Hi, Nathan.

Good afternoon. Appreciate you taking the -- I jumped on a little late, but I think I heard kind of a mid-to-high single digit loan growth outlook for this year. And just curious how you guys are thinking about the opportunities to grow the core deposit franchise in 2024. Obviously, it was a difficult year to grow core deposits in '23. So just curious how you guys are thinking about those opportunities, particularly in light of some of the improvements or enhancements on the technology side of things.

Yeah. I would just say that we feel great about our liquidity position, which is you saw us lead with that in the press release and early in the call, we talked about that $585 million change, $300 million of new cash, a reduction of borrowings of $285 million. And so I think it allows us to be smart around our deposit pricing, maybe a little more conservative than what we were in 2023. But I still think our expectations are always mid to low-single digit deposit growth. So if you think about 3%, 4%, is our target kind of year after year. If you think about normal environments, obviously COVID and all the stimulus kind of changed those things, but it does feel like we're starting to settle into a banking environment that feels more like it used to.

Okay. Great. And just thinking about the size of the securities portfolio going forward, I appreciate the disclosure around how much cash flow you have coming off this year. Is the expectation that just the portfolio shrinks by that amount or -- and you are able to just redeploy that cash flow and incremental deposit growth into new loans, or do you guys see need to maybe grow the securities book to some extent?

We're not planning to grow the securities book. We are planning to use that liquidity for loan growth.

Okay. Great. And then just one last question on credit maybe for John. I think in the past we've talked about a normalized charge-off range between 15 basis points and 20 basis points. Is there anything that you're seeing on the horizon that would cause you to deviate from that kind of historical trajectory into this year and next? Obviously, nice improvement in most credit metrics here in the fourth quarter, but just any thoughts on that kind of historical range as we kind of enter a still somewhat uncertain environment this year?

Yeah. Well, no, I don't -- actually, I wait for the question of what the run rate on charge-offs, what I think it would be, and I think of it really between that 10 basis point to 20 basis point range, absent any individual name that might pop up and you go through and you continue your portfolio reviews and your analysis of individual credits. And that still seems like it's reasonable to me given the level of classified, the level of criticized to pencil in.

Okay. Great. And obviously, you guys are still operating with a very healthy reserve as a percentage of loans and MPLs for that matter. Any thoughts on just kind of where the reserve maybe bottoms over the next year or two as a percentage of loans in terms of kind of how you guys need to provide for kind of that mid-to-high single digit loan growth outlook?

Well, I mean, it'll be likely that we'll take some provision to cover at least our loan growth during the year. We'll have to look at the changes in the economic scenarios. Obviously, that'll play a part in that determination. It might still tick down a little bit. We're at 164 for a coverage ratio now. We'll just have to kind of see how the year plays out with whether we get a soft landing or we get a recession. I think that's going to make a big difference.

Got it. Makes sense. And then just one last housekeeping question. Does the tax rate go back up to around 15% for the first quarter of next year or '24, excuse me?

Yeah. Typically our effective tax rate is around 15% to 15.5%. So I think that's what you should expect in 2024.

Okay. Great. I appreciate you guys answering the questions and all the color. Thank you.

Thank you, Nate.

Thank you.

Thank you. Our next question comes from the line of Brian Martin with Janney. Your line is now open.

Hey. Good morning, everyone, and thanks for taking the questions. Maybe just one for John or two. Just -- I joined late. Just -- John, did the -- did you talk about what the special mention credits did in the quarter? I know that you've got the classifieds in the deck. Just curious what the leading indicator there looks like. It sounds like everything is just very strong on the credit front. Just trying to look a little bit deeper at that.

Yeah. We don't have a slide -- sorry, Brian. My voice -- my speaker muted, getting waved down here. So, I don't have my -- we don't disclose our criticized assets within on the slides, but they've kind of trended with the classifieds and we're, from a commitment standpoint, pretty much flat for the quarter.

Okay. Yeah, that's help. I just want a direction just kind of how it's looking and it sounds pretty good. Just wanted to kind of confirm that.

Yeah.

And then maybe just one for Michele on the deposit repricing. Michele, that $2.5 billion, is that pretty immediate on the deposit repricing? I guess, I don't know what that was tied to index-wise, but assume it's pretty immediate.

It is, yes.

Okay. I got you in that front. Okay. And then maybe just last too, just on the growth outlook, it still sounds very strong. And obviously the focus is on the organic side. I mean, do you guys view or see opportunities out there on the M&A side? I mean there's a lot on your plate, listening to the call and everything going on, but just trying to understand what the opportunities may be on the M&A side, I guess in '24 and beyond.

Yeah. We continue to have communication with a handful of banks that we think would be great fits as part of our franchise. But I'm not sure the environment has really changed to make M&A really attractive yet. A reduction of interest rates helped some return of stock price has been helpful. And we're just going to continue to have conversations. And when sellers are ready and looking for partners, we'll -- hopefully it fits with all of the other initiatives that we have happening. Really pleased to get some of these tech projects behind us by mid-year, by June 30. And when we're in the middle of that kind of activity, there's just no way to really even think about M&A. So -- but the conversations are continuous and we continue to build relationships.

Yeah. It makes sense. I mean, organic focus is where you guys have been, and it's been doing a great job. And like you said, all these initiatives, you don't want to drop the ball on those and get those done. So -- and timing is not perfect just yet. So, okay. And then maybe last one for me, maybe for John or whomever, but just as you kind of look at the loan repricing this year, the renewals and the rate increases, I guess, have you taken a look at that portfolio? I guess, can you just give any commentary about how much risk you see in those loans? Repricing is from a credit risk, the renewals getting -- absorbing the stress of the higher rates, or you've done any type of color on that?

I missed kind of the first part. Are you talking about investment real estate specifically?

Not just in general, in the loan book, the repricing this year...

Yeah.

And the credit just being able to absorb the impact of higher rates as they reprice and just if you've kind of looked at that maybe on the chunkier credits.

So far, what I've seen across the portfolio is that customers have been able to either increase their prices previously and they've been able to absorb the changes in interest rates pretty well, quite frankly. You do see it in some -- in cases where the higher interest rates have led to slightly higher debt service or higher debt service. But there's been a series of maneuvers, either through increases of prices or reduction in expenses or something else in the income statement they've been able to compensate for. So, yeah, I mean, just see it -- you see it, but you've got good business owners there figuring it out.

Yeah. And Michele mentioned we have 900 million at a rate of 4.7% that are fixed rates that will mature in '24. And when we look through those, we're optimistic about how that helps earnings versus feeling like somehow you move into a credit issue.

Yeah. I got you. Okay, well, thanks for taking the questions, and a nice finish to the year, guys.

Thank you.

Thanks, Brian.

I'm currently showing no further questions at this time. I'd like to turn the call back to Mr. Mark Hardwick for closing remarks.

Thank you, Norma. Yeah, thanks, everyone, for your participation. We're -- we again really pleased with the year that we had, especially in light of some of the challenges that occurred throughout the industry, what people are referring to it as March Madness. And just -- it helped to validate this strength and the safety and soundness of our institution. And I think we end the year with a balance sheet that really is in an incredibly strong position that sets us up for success in the future. So again, we appreciate your investment. We thank you for your time and have a good rest of your day. Thanks.

And this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.