First Merchants Corp (FRME) 2010 Q1 法說會逐字稿

Good afternoon. Welcome to the First Merchants Corporation first quarter 2010 conference call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. (Operator Instructions) During the call, Management may make forward-looking statements about the Company's relative business outlook.

These forward-looking statements and all other statements made during the call, that do not concern historical facts, are subject to risks and uncertainties that may materially affect actual results. Specific forward-looking statements include, but are not limited to, any indications regarding the financial service industry, the economy and future growth of the balance sheet or income statement. Please also note this event is being recorded.

I would now like to turn the call over to Michael Rechin. Please go ahead, sir.

Thank you, Andrea. Welcome to everyone on the line for your participation in our earnings conference call and webcast for the first quarter ending March 31, 2010. I believe the instructions for participation and following along with our remarks on the webcast are provided in the -- towards the back of the press release put out earlier today. Joining me are Mark Hardwick, our Chief Financial Officer and John Martin, our Chief Credit Officer. My comments will begin on page 4 for those of you with access to the webcast. Our press release issued earlier today reflects results of operations and other significant activities completed last quarter. Our priorities as management remain addressing credit in managing all aspects of our loan and investment portfolios, more fully realizing efficiencies available from our charter consolidation completed late in 2009 and maximizing our opportunity as our markets begin to show signs of economic rebound. In regard to results, First Merchants Corporation posted a profit of $136,000 dollars or $0.01 per diluted share for the quarter. The earnings are primarily a function of steady net interest income with material reductions in expense to include loan loss provision and a lower run rate and core expenses and the backed by the stable net interest margin.

Later in the presentation Mark will walk through our pretax preprovision run-rate which remains strong. It still has inflated expenses associated with credit management, which will be detailed. We're pleased to see the net margin remain healthy, coupled with mixed results in some of our non-interest income categories, where we're beginning to focus increased efforts. Our operating expense levels decline we're very pleased it is one of the aspects we think has recurrence capabilities while the overall operating expenses are flat quarter over quarter first quarter '09 to first quarter 2010. We made significant progress in items such as salaries and data processing expense, recognizing the results of the charter combinations as we had planned.

Other items such as collection expense of all sorts, consumer, commercial, OREO right-downs remain at levels above where we would like them to be as we work through the credit climate with some clear view as to what those costs could be going forward. We made comments in the fourth quarter that we had hoped, that absent a setback in our credit statistics, that our provisions going into 2010 should better match our net charge-offs. We saw that in the first quarter with actual provision, $3 million plus or might minus, less than our net charge-off number. In contrast, to the $40 million excess of provision above net charge-offs and the result reserve build through 2009.

Lastly, we spent a significant part of 2009 management in our board continuously assessing our capital levels, in light of, well capitalized status in all the regulatory ratios, as well as, just what the market conditions were and an internal assessment of the remaining risk in our loan portfolio. We filed an 8-K in late March describing two transactions. The 8-K covered both the closing of a private equity placement of $24.2 million, which Mark will refer to, as well as, the approval from the Treasury to complete an exchange for up to $58 million of our existing CPP funding. At this point, I'll turn the presentation over to Mark who will walk in a more detailed basis through our first quarter results. Thanks, Mike.

Good afternoon, everyone. Thanks for joining our call. As Mike mentioned, we did produce a modest profit in the first quarter of 2010 by earning a penny a share and we're all encouraged to be back in the black and look forward to improving our numbers from this point forward.

If you turn to slide six, this speaks to Management's results regarding our plan of protecting and strengthening the balance sheet consistent with our 2009 and early 2010 guidance regarding our capital preservation plan. The loan portfolio declined by $516 million during the last 12 months, offering an improved risk profile as our earning asset mix is now more liquid and lower includes less risk, including $193 million of added investment grade securities. For a variety of reasons, including our achieved capital and liquidity risk profile improvements and improvements in earnings growth Management does not desire to see the loan portfolio continue to pay down at its current pace. The composition of our loan portfolio, on slide seven, is producing a strong yield of 5.74% and has a good interest sensitivity profile. $1.2 billion, or 40% of our $3.1 billion, in loans reprices daily and another $796 million, or 25%, of the portfolio will reprice during the remaining 12 months of the year. Just 35% of the loan portfolio is locked with a duration beyond one year.

We like how the portfolio is positioned for rising interest rates. The investment portfolio on slide eight is the beneficiary of additional liquidity over the last twelve months. The yields remain strong totaling 4.71% and the duration is still attractive at 4.4 years. Our other than temporarily (inaudible) investment securities, or FTN, FHLB's will -- which all of our remaining temporarily impaired investment securities are of the same nature, all Trust Preferred Pools totaled $6.6 million and have a market value of $1.4 million. Despite the sale and reinvestment of $41 million during the quarter, resulting in a $1.8 million gain and the unrealized loss on the Trust Preferred Pools I spoke of, of $5.2 million, the portfolio still maintains, on a net basis, a $7.4 million unrealized gain.

If you turn to slide nine, the improvement in our common equity since year end, is the result of the $24.2 million registered direct private placement of 4.2 million shares at $5.75, or 10% discount for the market at the date of close, which was March 30, 2010. The proposed conversion of up to $58 million of CPP to trust preferred will result in a reduction to line seven on this page for the total amount converted and will increase both lines eight and line six, and line eight, the increase will be the after-tax gain of the conversion will be the improvement and then on line six will be the net remaining amount of trust preferred that was are converted. We're pleased with the completed equity raised and the improvement in our market cap of just over $90 million since its announcement. We're equally pleased by the quality of the six new institutional investors that participated in the completion of the transaction. We believe the blue chip caliber of investors will be attractive to other fund managers as well. It was nice to see a six-party deal come together so cleanly, without the use of an underwriter or placement agent, and it just speaks to the quality of the firms we were working with.

The composition of the remaining liabilities, and I am still on slide nine, also improved during the year as customer non-maturity deposits increased by $90 million or 4.7%. Brokered deposits and borrowings declined during the period by $344 million and some of our highest price customer time deposits declined by $198 million. The improved mix as illustrated on page 11, or on slide 11, is satisfying management as demand deposits now total 37% of total deposits as interest expense on deposits now totals 1.6%. The change in our overall funding mix including borrowings is a catalyst behind our 44 basis points decline in our total cost of funds year-over-year. All regulatory capital ratios on slide 11 are well above the OCC and Federal Reserves definition of well capitalized. We're pleased that the total risk based capital expanded, during 2009 from 10.24% at the end of 2008 to 13.04% at the end of 2009, and now with the addition of $24 million in common equity totals 14.44%. Tangible common equity to tangible common assets declined during 2009 from 5.01% to 4.54% as reflected on the slide, but now exceeds the 2008 number of TCE totals 5.27%.

The CPP conversion is expected to close during the second quarter. We're currently working with legal counsel, our counsel as well as the Treasury's counsel, to finalize all the documents and when that transaction closes, it should improve our tangible common equity by somewhere between 15 and 20 basis points, depending on the exact amount that is converted and the mathematics or the discounted cash flow around our interest rate relative to the market. Net interest income on slide 12 declined by $2 million during the year. Our net interest margin did increase by 14 basis points, yet our earning assets declined 8% year-over-year. The allowance for loan losses on slide 13 increased $30 million during the last twelve months, to $88.6 million totaling 2.82% of total loans, up from the 1.6% last March. The reduction in the overall allowance from year end is the result of decreased specific reserves, as our FAS 5 pools did continue to reflect a modest increase. Total non-interest income on slide 14 reflects some volatility due to line six security gains and losses and when normalized for the portfolio activity on line nine, still results in a more modest decline of $500,000. The primary driver of that decline is the exploration of our interest rate floor derivative contracts back in the first quarter of 2009. If you recall, we had interest rate floors on a number of our prime base loan that we ultimately sold the floor and we were recognizing the gain on that sale. The gain was about $5 million. We were recognizing the gain over the remaining life and at the end of the first quarter that amortization ended.

Total non-interest expense on slide 15, totaled $34.7 million, down from the fourth quarter of 2009 by $5 million. The first quarter last year and the first quarter of this year were similar dollar amounts, as our ORE and credit related expenses increased during the year and are coming back down. Under our protect and strengthen and capital preservation mode of operation during the last 12 months, a reduction was expected, and necessary, as our salary and benefit expense totaled $17.6 million during the quarter, a 12% decline from the first quarter of 2009. Total FTE's during the year declined by $124 million, or 9.5%, during the period. Our ORE and credit related costs along with professional services related to credit costs have improved from the third and fourth quarters of 2009, but still remain high at reflected on lines four and five.

Please turn to slide 16. We're pleased with our return to profitability and we are pleased with the new look of our balance sheet and our income statement. The improvement year-over-year in our pre-tax pre-provision run rate is encouraging. As credit quality continues to improve, so will our credit and credit related costs and our actual net income. Now John Martin, our Chief Credit Officer, will discuss our asset quality trends.

Thanks, Mark. I will be walking through the credit slides, numbered 18 through 26, of the presentation before turning the call back over to Mark. Starting with the delinquency, 30-plus days delinquent decline from $40.5 million, or 1.29%, of total loans to $34.2 million, or 1.09%, of total loans. This marked the third consecutive quarter of declines in the category while loans that were 90-plus days delinquent declined from $4 million to $2.6 million, also marking a third consecutive quarterly decline. While challenges remain, delinquency, as well as other, trends point to improvement in stabilization in the portfolio. Non-accrual loans increased from $118.4 to $122.9 million despite the addition of $38.6 million in new non-accrual loans for the quarter. Total non-performing assets and 90-plus days past due declined from $146 to $144.6 million. Additionally, the allowance is a percentage of total loans increased to 2.81% to 2.82% with allowance coverage now at 72% of non-accrual loans.

While on slide 23 we will walk through the reconciliation of our non-performing assets and 90 days past due. Suffice it to say, we continue to see some improvement and stabilization. Now, if I could have you turn to slide 19 and 20, as just highlighted, non-accrual loans increased from $118.4 to $122.9 million with the top three relationships representing roughly $19 million of the total. The largest, a $10.1 million loan, is secured by real estate. The loan was for the construction of a hotel located in Indianapolis market and was impacted by the recession and unable to reach expected stabilization, project stabilization. The property is open and continues to operate although at levels that are below what was originally planned. We are in the process of working with the borrower to resolve this situation.

To provide some color around the multi-family and residential real estate non-accruals, the properties are located in Bloomington, Indiana and are secured by apartment buildings, as well as, other collateral. These projects are complete, remain open, occupied and leased, with the central issue relating to other projects in the customer's portfolio and impacting their ability to repay. Finally, the medical office building located in the Anderson market, did not achieve the level of expected rents and, like the other borrower's I just mentioned, we continued to work with them to resolve these situations and, to the extent necessary, we have specifically reserved potential losses.

Now, please turn to slide 21. Other real estate owned increased for the quarter from $14.8 to $18.2 million. During the quarter we were able to fully liquidate 32 properties totaling $3.7 million. While this category increased for the quarter, the majority of the change results from two properties to related borrower's totaling $6.2 million that had been on non-accrual since the start of 2009. The property is two parcels of land in the Indianapolis market, zoned industrial and appraised at year end well in excess of the amount currently held in OREO. We are now marketing -- are now working with interested parties to clear the way the market and liquidate the property. We've had a good teal of interest in the property and believe that is readily marketable.

Absent this addition, other real estate own continues to be stable for the quarter, although as I will highlight in the credited metric slide, trends in non-accrual consumer one to four family residential real estate loans are likely to impact the absolute number of OREO properties in the coming quarters.

Now , please turn to slide 22. Just briefly I wanted to once again highlight the delinquency trends. As you can see, delinquencies continue to improve in both 90 plus and 30 plus days past due. Declining respectively from .12% to .08% of period end total loans and from 1.23% to 1.09% period end loans. These trends combined with the flattening of the non-accrual loan once again point to stabilization in the portfolio.

Please turn to slide 23. Given the movement in the individual categories, the table on slide 23 reconciles the MPA components in order to highlight how the changes in nonperforming assets declined for the quarter. Let me walk you through those changes now. Year end 2009 MPA's, and 90 plus days past due, total $146.1 million for the quarter. Non-accrual loans were $38.6 million which includes a significant non-accrual loans listed on slide 20. We were able to return to accrual restructure or refinancing $7.5 million, and we moved to ORE after charging off approximately $1.1 million, another $8.4 million. And finally, we charged off $17.1 million of non-accrual loans.

Recapping ORE for the quarter. New other real estate owned increased by $8.4 million and we sold $3.8 million, and wrote down another $1.2 million, associated with the sale of properties for a quarterly net increase of $3.4 million. As mentioned previously, 90 days past due decreased by $1.4 million and we moved $8.8 million from restructured as a result of demonstrated performance and we added $800,000 in new producted loans netting to the $8 million change. These changes result in the net quarterly change in non-performing assets and 90-plus days past due of $1.5 million reducing overall NPA's and 90 days past due to $144.6 million.

Please turn to slide 24 while I will discuss the charge-off in trends. Net charge-offs for the quarter declined from $20.8 million to $17.4 million. As discussed last quarter, one commercial industrial relationship was moved to non-accrual as it became apparent that the customer, who was severely impacted by last summer's bankruptcies in the automobile industry, would not be able to continue to meet its obligations under the contractual terms. The customer continues to operate and while we have strategies in place with the customer to resolve the situation, the decision was made during the quarter to charge-off the specific impairment reserve. This caused the most significant impact in the C&I and charge-off ratios. The charge off was fully reserved for in the prior quarter and we believe this represents the full loss associated with the borrower. We continue to work with the customer to resolve the balance of the loan and anticipate resolution over the coming quarters. Charge-offs for the top five customers averaged $3 million although a disproportionate amount of that, again, was related to the manufacturer I just mentioned.

And finally on slide 25. I would just like to recap the allowance coverage of the non-accruals and the declined 72% as specifics were charged down relating to the individual credit while overall the allowance increased from 2.81% to 2.82% of total loans with balance increases being driven by our allowance methodology. So then on page on slide 26, I have bulleted some key factors that I believe speak to the current state of the portfolio. I will summarize these before turning it back over to Mike for his closing remarks.

I've used in a number of different points within my speech the term stable and let me tell you why I think that is the case as I walk through this slide. As you can see, classified loans declined for the quarter from $305 to $286 million and that was even further down from the third quarter of $325 million, that's third quarter 2009. Next, the non-accruals coverage is in line with the third quarter and the non-accruals loans are flattening as we moved into the end of the first quarter. Then in terms of the five largest accruing relationships that bucket, that might otherwise move from accruing to non-accruing, averaged $6.3 million with none exceeding $10 million. So, what is left which is classified is somewhat smaller than some of the larger numbers that have impacted us more recently. The ten largest overall bank commitments and outstanding balances averaged $15 million and $11.8 million respectively. So, on balance the portfolio remains granular and the potential problems then -- relative to some of the most recent numbers that is came out relatively small.

Finally, the provision expense are -- then the provision expense is model dependent, as I just mentioned, and absent any specific reserve that might come from those two previous bullet points, is really going to be dependent upon the AS450 pools and the model being driven. Then, the 30, to 89 and 90-plus days past due, again, improving and stabilizing. And then finally, with the portfolio stabilizing, we have now seen a year of performance from our workout team of eight individuals, that have been with us now and formerly handling our largest and most significant credits, and these individuals are seasoned and have now begun to make progress or continue to make progress in the existing portfolios and the existing non-performers that we do have. So, with that I will turn it back over to Mike for his closing remarks.

Thank you, John Martin. We're going to open up the lines here, Andrea, in a moment or two for questions. I will give you a queue on that if you would. I just have a couple thoughts I would like to add. One of them would be on John Martin's thoughts. No one in our company feels like the credit cycle is complete nor his comments around the stabilization to be predictive of what we don't know about what happens next. I think we're really clear about his confidence in the handling of our portfolio. He referred to a timeframe in terms of three or four quarters of maturity of his team's efforts. The reality is we have more talent, better talent and improved collaboration, not just amongst our credit administration folks to include our special assets, but around the entire company afforded us by much of the hard work in getting a cleaner understanding of our portfolio by way of charter combination and quite frankly a simpler company to manage with the credit cycle continuing. The collaboration between our market leadership and our relationship managers in tandem with John's and Mike Stewart's leadership is produced the ability to speak to stabilization knowing that the economy doesn't have its feet under it in a dramatic way.

I would like to offer a thought on Mark's comments where he referred to being pleased with the result of a better balance sheet. The better looking balance sheet fortified by capital is better in regards to the credit profile. No one on our team is satisfied with either the caliber of the portfolio nor the results that it is producing. We are pleased at least to show a penny of profit. There is a significant amount a of work yet to be done. Mark referenced the completion of the exchange with the Treasury. We would expect that. We're confident that that should not take on a timeframe beyond the end of this quarter. We're actually hopeful it would be towards the front end of the quarter with the attendant benefit that incremental add to our tangible common equity.

On page 29 on the summary thoughts, I referenced continuing to improve our asset quality. I also referred there to all-in credit costs, many of which, continue to plague our operating expenses. I feel with our salary expenses and some of our facility and data processing expenses managed down to the level that they are, they have a little room yet lower to go coupled with lesser expenses in what we call credit related expenses. We feel our efficiency ratio, which was 62.5% roughly for the first quarter, has room to go down and our plan calls for that.

My last couple of thoughts relate to the customer, which hasn't been vocalized enough through the balance of this call. One of them would be the hands on effort we're going to make around the implementation of our Reg E strategy, which is currently focused and prioritized around internal education, so that our troops can speak to our clients eyeball to eyeball about what we feel is in their best interests. It will immediately be followed by customer education and ultimately, and with a choice, that will ask them to make as we serve their needs. In the middle of the page, I refer to other customer and revenue related activities.

I would be remiss if I didn't balance the scales that while we have spent hundreds of hours around the needed improvement in the our credit profile, the customer has never left our eye. And while our balance sheet is smaller, we work on important initiatives such as the fourth quarter rollout of a new benefit rich feature rich lock box for our commercial customers, a current period current quarter rollout of a commercial card for our customer's benefit, and we look to the fourth quarter of this year when we revamp and muscle up our online banking, all of them sharing the spotlight as we put our resources towards returning to the performance that First Merchants has had in the past. So, with those summary comments, the three of us would like to take questions from anyone that should have them. Andrea, if you could open the phones, we're ready.

(Operator Instructions) At this time, we'll pause momentarily to assemble our roster. Our first question is from John Rodis of Howe Barnes.

Good afternoon, guys.

Hi, John. Good afternoon.

Mike, I sort of missed what you said just recently on your thoughts on operating expenses going forward. I thought you went over that a little bit.

Yes. You can see the biggest component of it is the direct people expense. I think our salary level was $1.1 million down fourth quarter to first quarter. There is a little bit of room left in that. Mark highlighted it in terms of FTE's.

I just shared with you the dollars. We have been doing the execution of the follow through, if you will,l going back five quarters to the Lincoln transaction, we've gotten all of that work reconciled. A colleague of mine likes to talk about top grading our talent. We haven't stopped evaluating, do we have the right people and the right places? So, we're not going to stand still but that category won't grow. The other operating expense is that we think can come down are the credit related ones that show up in that category. Not to be confused with loan loss provision, but all of the size of the special assets group, the costs, the outside lawyering, the appraisals, and the OREO where it continues to be at a really expensive clip that we think should normalize. In actuality, it normalized less on a percentage basis than did the provision.

Okay. Thanks. Maybe a second question? I think you touched on it a little bit as far as just the continued run-off in the loan portfolio, and I guess over the last say five quarters or so, you have seen on average a drop of about 100 million in the loan portfolio each quarter. Do you see -- I mean, I would expect the pace of that decline to slow some, but I would assume you're still going to see a continued decline going forward for a while?

I do. This is Mike again, John. We do. We don't want that to happen. We have a couple of things that come together. One is just the raw demand of the market which we would consider to be weak, although our pipeline is at a healthiest point it has been in awhile. It is still weak compared to 2008 for certain. Within the loan portfolio itself, John, just a couple of additional thoughts and I am looking at that trend at the back end of the press release that has the five-quarter stretch. You might be looking at it. A couple things.

We're a very hopeful to continue to take advantage of the consumer activity. And lost in those numbers, and what should begin to even out, is the run off of the indirect portfolio which is in some of those categories. We've had about a $2.5 million run off and the portfolio is modest at this point. It is somewhat masks our appetite to do business with consumers. In addition to that, on the C&I caption I was looking at that, and if you go back to five quarters as you have, it looks like a 30% reduction from the first quarter of 2009 to the first quarter of 2010. And in fact as we look at it, it is more like 20% when you recognize the amount of owner occupied real estate that would show up in the commercial mortgage category on that same sheet. About $500 million plus or minus actually more like $550 million. So, when we look at it from a pay master standpoint, coupling the exposure of owner occupied real estate with the call code referenced C&I lending, it is down. We would like to see it reverse. It is down more like 20%, not 30%. I referenced pipeline, so a little bit more healthy. I have those numbers here. It is up a little bit.

When we look at reporting that we do for loan activity in the fourth quarter, off the reports that we submit, we had about $240 million of activity which includes a big piece of renewal activity. When we look at pipeline we're typically looking at incremental credit to existing customers or new customers and so it's the healthiest it is been in awhile with about $180 million of commitment. So, a little bit of reason for encouragement. We think the rate of run-off should slow, but when you consider the magnitude of the non-accrual assets we still have those are exit strategy names.

Fair enough. And just with kind of the change in mix of the balance sheet. If the loan portfolio continues to trend down, what are kind of your thoughts on the margin he heading forward assuming rates remain stable?

I will let Mark speak to that. The thing I know can happen, we can't control the rate of either new opportunities or those new opportunities that we actually close. We do know that in terms of a margin, I think, we still have a nine-figure number, $100 to $150 million of scheduled maturities of Federal Home Loan Bank advances and brokered CD's that mature in the next four quarters. So, as those roll off, somewhat independent of the volume of new loan activity, there is a pickup for us there. You have already seen, and Mark might speak to, there getting points -- crossing the point where increases and that interim margin can't keep up with volume at some point.

We expect to see margin continue to improve slightly. We had a January margin of 393. Ultimately, that didn't result in that strong a number at the end of the quarter. We had seven basis points of interest reversals that happened during the quarter. It is a small item in terms of number of days, but it does impact our financials pretty significantly. It was a 90-day quarter and we have about $500,000 of income on commercial loans that accrues per day. We have the first quarter is the smallest number of days and then we have 91 and 92 days in the remaining quarters of the year. So, it is a $500,000 to almost $1 million dollar difference in subsequent quarters, so still feel optimistic about being able to maintain our margins to possibly continue some expansion. We have talked about trying to get to the 4% level. It is a goal I don't know if it will happen. But we don't see anything coming in terms of headwinds that would cause the number to decline from where we are today.

Okay. Maybe just two more questions and I will be done. Just, Mark, can you maybe address the tax rate? Do you expect what sort of rates should we model going forward or do you expect more credits and then second, on the FDIC costs I guess that was down? Is the $1.7 million a good number to work off going forward?

The tax rate is ultimately, as we add profitability, the tax rate will creep up because we have the same number of tax exempt items as we do today. So, our tax rate for state purposes is essentially zero and our federal is 35% and then we have a number of items that hold down the federal rate. I don't know the best rate for modeling. It is probably in the 25% range depending on the amount of growth that we see in the income statement. On the FDIC assessment, this is a pretty good run rate. We think there might be a little modest increase as we go through the remainder of the year, but we have a number of charges from last year behind us and we have a more normalized rate at the end of the first quarter.

Thanks, guys.

Thanks, John.

Our next question is from Scott Siefers of Sandler O'Neill.

Good afternoon, guys.

Scott, good afternoon.

A couple of questions. I think John got to most of mine. Maybe, John question for you just on the decision to bring the reserve down a bit. Can you just maybe give a bit more color on exactly what the main driver of the reserve level would be in? I know you had the improvement in delinquencies, which I imagine is a big piece of that. Then I guess, more importantly, as you look forward what additional strength would you have to see in credit indicators to bring the reserve down further?

Scott, in terms of what drove it this last quarter was the, we had a significant specific reserve related to the individual borrower that drove it and then the balance of the model, as I highlighted in that last slide, is really driven by that AS450 our methodology around that. An in terms of the overall level that we have right now, I would say that it is going to be dependent upon what the model drives, as well a,s any specific reserve that is come out of the portfolio related to any incremental credit.

Scott, this is Mark. The reserve dropped by about $3.5 million and our specific impairment reserves dropped a quarter from year end to the end of the first quarter by 4.5% and then the ACS, or the old FAS 5 pools, increased by about $900,000. So, I think it is just important to monitor specifics versus the rest of the model as we go through the rest of the year.

Okay. So those all did sounds like net out to kind of the appropriate number there. Is it then fair to say that maybe assuming this kind of stabilization continues to hold true, that maybe sort of matching the provision with charge-offs, fair way to think about things going forward?

We think matching is a fair way to think about it. We had a larger than normal charge off of a specific reserve with that $11 million.

Yes.

That we decided it just didn't need to be fully replaced.

Okay. Perfect. Then I guess, Mark, just question for you on the TARP conversion? You still have the range out there, I guess up to $58 million. Who ultimately will determine how much actually gets converted? Is that you guys, or the Treasury, or is it just some dialog back and forth? How does that process or that part of the process work?

It is really at our discretion. They gave us an approval of an amount up to 50. I am sure, some level it is de minimus, and they would say it isn't worth the effort. But we have approval up to 58 and based on all of our risk based capital models, wanting to maximize the gain in TCE and not give up much in terms of the overall risk base, we want as much as possible to count in the core capital elements. We think we're going to be landing on probably a $50 million number so we're close to the $58 million, and still need to be finalized, but that's the what we're looking at right now.

Okay. Perfect. Thank you very much.

Thanks, Scott.

Thank you. Our next question comes from Jonathan Elmi of Macquarie.

Thanks, guys. A couple of quick follow-ups the net interest margin. Can you quantify the impact the rising rates on margin and how much rates have to come up to bring up your loan yields? Not sure to what extent you have floors in place, et cetera?

We have performed the modeling, as all banks do, and we still show that up 100 basis points that we have expanded margin of about $1.1 million. I think is the number I was looking at it yesterday. That's the reason I walked through the specifics of the loan portfolio as it relates to interest sensitivity. We feel like we're positioned well for rising interest rates because of those pricing schedule that is I mentioned, and again it is $1.2 billion or 40% of our total, that has a daily reprice. And of that amount, we are about 25% to 30% tied where we have interest rate floors where there is kind of that dead zone where rates would move and we wouldn't see the benefit. Then another $796 million priced throughout the remainder of the year and the remaining 35% is more than one year. So, a large amount of demand deposits where we have the ability to kind of lag interest rates in a rising rate environment. We very much feel like an increase in rates would still produce an expansion in our net interest margin.

Okay. Great. That's really helpful. Also just looking at the deposit cost as well. It looks like sort of the overall cost of liability is kind of held in pretty stable this quarter. I mean, how much more room do you guys have to bring down your funding costs?

You know, I think it is going to be pretty stable as we go forward. We're continuing to work some of the larger balances where, during the liquidity crunch that was throughout the banking industry, we stopped our decline in our rates to maintain those accounts. They're priced out of the market today, been valuable customers we make nice net interest income off of them and continuing just to evaluate where we have some modest reductions available. I wouldn't anticipate any noticeable or material decline in our costs of overall funding.

Great. One more quick question on the credit side. Just wondering if you have any color around what you are hearing from some of your small business borrowers? What the tone is, what you're seeing the year end financial statements that have been trickling in?

Yes. I think, in genera,l we've in terms of the demand and the overall pipeline, it is fairly sluggish. The results we're getting back on the smaller end of the spectrum are obviously impacted by what occurred last year. But it is situational obviously and depend end upon the industry they're in, but on balance the customers that capitalized have been hanging in there, and the performance has been stable to slightly down as a result of the what happened last year.

I would add, that from what I see small business to write up through the middle market is top-lines that aren't growing that quickly and better reaction on business owner decisioning around expense levels that make for less strained cash flows than ultimately a better repayment profile.

Okay. That's all I've got. Thanks, guys.

Thank you, John.

Our next question is from Brian Martin of fig partners.

Hey, guys.

Good afternoon, Brian.

Just with regard to credit, just talking sounding like things are pretty stable here. I guess -- can you just give a little bit of color on your expectations on the provision -- that I guess, is it fair to assume, I realize there is one offer that is to come along but if credit continues to hold, this might be the high water mark on provision for the year?

You know, we're using the model as appropriate. We're looking at all criticized loans, trying to get our arms around what could be coming and I don't know whether to call this a high water mark or not. We certainly hope it is and we don't see evidence anywhere that says that we should hedge otherwise. But we'll see what the year brings.

Yes. I don't think any of the three of us would give you an affirmative answer to that, not out of known reason, but when we look at $13 or $14 million of provision as we had in the most recent quarter, and it wasn't that long ago when the results were dramatically different than that, 2009 in some regards. I am happy to feel far away, but we're cognizant that the economic climate that caused the provisioning hasn't changed that much.

Okay. And as far as kind of the back along that point where things are pretty stable. When you look at the portfolio at this point and comment earlier about the C&I kind of slightly down at this point, where in your mind is the biggest risk in the portfolio at this point kind of in the credit cycle and given where you are at today?

I think, Brian, as we look at the portfolio we're reviewing it, and the largest list is again turning that final slide, but I think as I look at it, it is non-owner occupied commercial real estate still has some level of concern, but again I would say that, we have been through the largest relationships and we don't see coming out of those any significant material name that would otherwise give us rise for concern at this point.

Okay. And then just coming lastly, just on the OREO and resolution of non-performing. If things do hold stable, which is seemingly what kind of what you guys are expecting, absent any surprises, then what are your plans or expectations as far as moving some of the stuff out as far as getting numbers down moving directionally the right way? Is that your expectation? I guess can you give any color on what may be occurring over the next couple of quarters as far as what you're seeing now?

Well, I think when you look -- there is a couple of things that I think to back up and answer the last question if you look at the trend in our Res one to four family, there is a level of concern there as well. You'll see that that number is a percentage of total portfolio continues to rise. Obviously, the home values associated with those are reason for concern and then as it relates to what was the second part of your question, Brian?

I guess I am just trying to get a sense for if things are starting to stabilize, how quickly do you think you can move some of the stuff out of the non-performing bucket?

Right. I think in terms of the OREO, which I think is where you started your question.

Yes.

I would say that, as real estate prices are stabilizing, it helps us because we're taking current values on them, so that's the current value of the real estate and it allows us to be able to put them on the market and sell them. So, to that end, stabilization, real estate prices are helping and our plan is obviously to liquidate out of the OREO that we do have there. Got strategies and plans and it is all being marketed as we stand.

Are there any big projects that you expect or just at least non-performing that could get pushed out of the next quarter or two or is it a lot of smaller things that might add up, or there is no one big thing that you think is you're expecting as far as timing of resolution in the near term?

We're again, if you look at the portfolio, that 6.2% that I mentioned in that last slide is probably the single individual property within this portfolio and the resolution on that, it will take time to do and it will an dependent on who ultimately will be the final buyers. I don't want to give you a quarter or two quarters specifically because so many things could impact the ultimate resolution.

Okay. All right. That's all I had. Thanks.

Thank you, Brian.

Gentlemen, at this time we have no further questions. Do you have any closing remarks today?

Very brief, Andrea. I appreciate you hosting the call and the interest of all of those that had questions or listened in. Any of us are available should the material or the answers give rise to additional questions. Appreciate your interest in First Merchants and look forward to talking to you again in three months. Good afternoon.

Thank you. This concludes today's conference. You may now disconnect.