First Merchants Corp (FRMEP) 2022 Q3 法說會逐字稿

Good day, and thank you for standing by. Welcome to the First Merchants Corporation third quarter earnings conference call. (Operator Instructions)

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 may refer to non-GAAP measures, which are intended to supplement but not substitute for the regulatory comparable GAAP measures. The press release available on the website contains financial and other quantitative information to be discussed today as well as a reconciliation of GAAP to non-GAAP measures.

I would now like to hand the conference over to your speaker today, Mark Hardwick, Chief Executive Officer. Please go ahead.

Well, good morning, and welcome to the First Merchants Third Quarter 2022 Conference Call. Michelle, thank you for the introduction and for covering the forward-looking statement on Page 2. I -- we released earnings -- our earnings today at approximately 8 a.m. Eastern. You can access today's slide by following the link on the second page of our earnings release.

On Page 3, you'll see today's presenters and our bios to include President, Mike Stewart, Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki.

Page 4 is a snapshot of the first merchants geographic footprint and some relevant financial highlights for your review. Given the close of Level 1 Bancorp on April 1 of this year, you will notice an updated thinking center map highlighting our now 122 locations across 4 states. We also continue to receive meaningful awards for customer service, leadership, work life balance and performance from publications like Forbes, Newsweek, S&P and comparably.

Now if you would turn to Slide 5, reported earnings per share for the third quarter totaled $1.08 compared to Q3 2021 results of $0.98. When adjusted for PPP income and Level 1 acquisition expenses, our Q3 2022 EPS totaled $1.12, an increase of $0.25 per share or $0.29 over Q3 2021's adjusted total of $0.87 per share. Organic growth in loans of 10% for the quarter and 13.5% year-to-date, when combined with core margin improvements of 28 basis points for the quarter and 23 basis points year-to-date are the drivers to our EPS improvements. Our system integration of Level 1 is complete and was exceptional in many areas and more challenging than anticipated in others. Our teams in both Michigan and our legacy markets quickly resolved issues with professionalism and customer service mindset that makes me proud. We also continue to streamline the branch network as evidenced by 5 completed consolidations in 2022.

The year-to-date earnings per share story when normalized for PPP income and acquisition accounting resulted in year-to-date 2022 earnings per share of $3.01, which is 18.5% better than our 2021 total of $2.54. Third quarter return on assets of $1.43 and return on tangible common equity of $20.85 evidence the strength of our combined companies post acquisition and still include some acquisition costs.

Michele will highlight a few additional adjusted ratios like the pretax, pre-provision earnings and our efficiency ratio later in the material.

Mike Stewart will now provide color on our lines of business. His continued presence in the Michigan market with employees and customers has been valuable. And I'll just add that our 150 employees strong appreciation dinner this past Thursday was full of energy and excitement. I can't really express just how encouraged I am by the talent of our new Level 1 colleagues.

Yes. Thanks, Mark. And I agree with that statement, spending time in the Michigan market as I do in many markets is exciting and being able to meet our clients, work with the teammates continue to see the opportunity is really a wonderful thing for First Merchants Bank.

I'll have us focus on Page 7, right? Business highlights. The top of the page offers the breakdown of the core loan growth by our business units. The third quarter represented another solid quarter of working with our clients and prospects borrowing needs that delivered the annualized growth rate of more than 10%, excluding the PPP loans. As discussed in our prior calls, we strive for high single-digit annualized growth rates and these results achieved those targets. As this morning's news release noted, total organic loan growth for the past 12 months has been over 13%, and last quarter, the growth rate was over 20%. The Commercial segment loan balances now total $9 billion of the $11.5 billion loan portfolio. The 2.3% rate of growth for the quarter was at a slower pace than the prior quarter of 13%.

New business activity was solid as measured by new name generation but line of credit usage declined this quarter as many clients are now highly focused on loan balances, given continued steep rise in interest rates. That behavior is also a primary driver of the decline in commercial deposits that you can see on the bottom section of this slide.

The commercial pipeline ended the quarter at the highest level this year. We measure pipeline by both credit that is currently within our approval channel and credit within a proposal phase, both are at the highest levels. The drivers of the commercial growth in the C&I segment continues to be the expansion of plant and equipment to meet growing demand of products and services for our clients, while line of credit utilization rates declined, our revolver commitments increased due to the continued inflationary pressures pushing up the values of working capital assets.

Working capital cycles on the other hand, are not necessarily slower than the prior period as the supply chain issues have not been further constrained. The second driver continues to be succession planning events within the ownership of middle market companies.

Our sponsor finance team and ESOP transaction benefit from these sell-side events. We have maintained a consistent and disciplined approach towards underwriting within these segments. The last driver is the increase this quarter in investment real estate footings. Construction projects have continued to fund throughout the summer, and there have been a slower pace of project refinancing into the secondary market. Our underwriting approach has remained consistent within the primary asset classes we focus, which is multifamily, industrial, warehouse, student housing, medical office and self-storage.

Let see, let's move on to the Consumer segment, where loan growth picked up the pace in the quarter reflected by the 21% annualized growth as compared to the 14% growth year-to-date. The quarterly increases can be attributed to home equity loans, private wealth relationships and small business activity. The home equity activity is correlated to the continued increases in home values and our average utilization of the portfolio has remained the same 2 quarters.

Our underwriting approach remains unchanged in all of these categories as well. At the end of September, the consumer loan pipeline remained solid but lower than the prior quarter. Consumer deposit balances declined for the quarter, you can see on the bottom. We have brought the former Level 1 franchise deposit base in alignment with our pricing disciplines post our integration at the end of August. This effort is now complete, and we look to drive deposit balances through our relationship model and connectivity to our whole bank efforts.

The consumer team continued to gain new accounts through both in branch and digital online activities. Our investment last year in a new digital account opening process hit a high point last month with over 18% of new consumer DDA accounts being opened through the digital channel.

So let's discuss the loan growth within the mortgage portfolio, which increased roughly $187 million in the quarter. The on-balance sheet residential portfolio now totals $1.7 billion. The driver of the quarter and year-to-date increases come from continued strength in purchase volumes with more of our clients choosing 5- and 7-year adjustable rate product offerings. Our underwriting standards remain unchanged, prime borrowers. With the continued increases in 15- and 30-year fixed rate options, our clients have chosen our shorter-term adjustables.

Michele will review the noninterest income detail where mortgage gain on sale remained muted as refinancing volumes are still at historical low levels. The pipeline for our mortgage team ended the quarter higher than prior year, but less than the end of June. Purchase and rehab volumes now exceed 70% of both the originated and pipeline units.

On an overall comment, the economic and business climate across all of our markets remain stable. We continue to see the resiliency in the management teams of our companies and households we serve. Our team remains responsive and ready to support our growth plans of high single-digit growth to close out the full year 2022.

A few more comments about our expanded Michigan market and to continue Mark's earlier statements. The Level 1 system integration was completed at the end of August, our new teammates, along with many legacy first merchants folks have worked tirelessly through this change event. Collectively, they have worked with our clients and have built the foundation for future growth in Southeast Michigan, Ann Arbor and Grand Rapids.

I remain impressed and quite frankly, optimistic that their strong growth culture and demonstrated track record of winning will continue. I'm going to turn it over to you, Michele, to provide more review of the quarter results, and we can then get to John for the soundness of our portfolio.

Thanks, Mike. My comments will begin on Slide 8, covering third quarter results. You can see our balance sheet growth on lines 1 through 5 and that we continue to trend towards a more favorable earning asset mix.

Total loans on line 2, which Jamie covered in his remarks, increased over $290.6 million through organic growth during the quarter, which was offset by PPP loan forgiveness of $21.7 million. Deposits decreased $136 million during the quarter and investments on Line 3 decreased $335 million. Liquidity from the investment portfolio funded our loan growth this quarter. As a result, our loan-to-deposit ratio continued to trend up and was approximately 81% this quarter compared to 73% in the prior quarter.

Mark covered earnings per share for the quarter in his remarks, rising yields on the loan and investment portfolios drove higher profitability this quarter, which is reflected in the increase in net interest income on line 11 of $11.6 million. Noninterest income also increased $1.3 million, which you can see on Line 13. Noninterest expense on line 14 remains elevated, which included $3.4 million of merger costs. Our stated efficiency ratio was 53.34% but was a low 51.39% excluding merger costs, reflecting strong operating leverage. The tangible common equity ratio on Line 6 declined 38 basis points, and the tangible book value per share on line 26 declined $1.19 as those metrics continue to be impacted by changes in the unrealized loss on the available-for-sale securities portfolio.

Slide 9 shows our year-to-date results. Line 25 shows year-to-date earnings per share of $2.62. Pretax pre-provision income year-to-date was $205.1 million, an increase of $19 million or 10% when excluding merger costs. Keep in mind that prior year-to-date pretax pre-provision income included $27 million of PPP fee income. So year-over-year, the core growth was exceptional.

Slide 10 shows highlights of our investment portfolio. On the bottom right, you can see we had a net unrealized loss on the mark-to-market of the available-for-sale security portfolio of $392.5 million compared to last quarter's loss of $246.1 million. Although the mark-to-market adjustment is meaningful, half of our portfolio is classified as held to maturity and protects equity from the decline in value for that portion of the portfolio. In the bottom left, you will see the cash flow we expect to receive from principal roll-off totaling $260 million over the remaining months of 2022 and for the year 2023. In addition to this principle, we will also receive an additional $100 million of interest income from the portfolio. So we will have a fair amount of liquidity provided by the investment portfolio over the next 15 months without selling securities.

Slide 11 contains highlights of our loan portfolio. In the bottom left corner, you will see the stated third quarter loan yield increased 67 basis points from 4.76% from last quarter's yield of 4.09%. Yield on new and renewed bonds increased significantly from 3.87% last quarter to 4.96% this quarter, an increase of 109 basis points. On the bottom right, you will see $7.7 billion of loans of 66% of our portfolio are variable rate with 42% of the portfolio repricing in 1 month and 52% repricing in 3 months, so we will continue to see meaningful increases in interest income from the loan portfolio as the Fed continues to increase rates.

Slide 12 shows the details related to our allowance for credit losses on loans. We did not record any provision expense during the third quarter. The provision expense recorded year-to-date was to establish the CECL day 1 allowance associated with the acquisition of Level 1. During the third quarter, we had net recoveries of $400,000, which brought the ending allowance for credit losses on loans to a robust $226.7 million. The coverage ratio trend is shown in the graph on the top left. Our coverage ratio at the end of Q3 was 1.94%, down from 1.98% from prior quarter due to strong loan growth. This reserve, coupled with the remaining fair value accretion of $34 million provides excellent protection as we head into an uncertain economic environment.

Now I will move to Slide 13. The total cost of deposits on the bottom chart shows deposit costs increased this quarter by 23 basis points, up to a total cost of 46 basis points, reflecting the strong pricing discipline we've had in this increasing interest rate environment. Our interest-bearing deposit betas this quarter were 20%, which were flat compared to prior quarter. Competition for deposits has increased significantly, and we do not expect our deposit beta to remain at the current 20% deposit beta.

Slide 14 shows the trending of our net interest margin. Line 1 shows net interest income on a fully tax equivalent basis of $146.6 million. When you back out noncore interest income items such as fair value accretion on Line 2 and the impact of PPP loans shown on Line 3, our core net interest income totaled $143.1 million, which is shown on Line 4. Compared to the prior quarter total of $130.7 million, the increase in core net interest income was $12.4 million, reflecting our higher loan yields, stated net interest margin on Line 7 totaled 3.55% for the quarter. Adjusting for fair value accretion and the impact of PPP loans brings us to core net interest margin of 3.47%, which is shown on line 10, an increase of 28 basis points from last quarter's core NIM of 3.9%. The -- the tax equivalent yield on earning assets increased 53 basis points and cost of funding only increased 26 basis points. We will see additional NIM expansion next quarter with the expected Fed rate increases in November and December.

On Slide 15, noninterest income totaled $29.6 million for the quarter, with the acquisition of Level 1 contributing a couple of million of noninterest income per quarter in Q2 and Q3. Customer-related fees this quarter totaled $22.9 million, a decrease of $2.9 million from prior quarter. The decrease in service charges on deposits reflect changes to our overdraft practices put in place midyear. Mortgage loan production is still strong at $275 million in loans were originated this quarter. We retained approximately 75% of those loans in the portfolio and sold only 25% of them in the secondary market, causing a reduction in the gain on the sale of loans and noninterest income. Derivative hedge fees and wealth management fees were negatively impacted by the markets, derivative hedge fees has slowed because of the rising rate environment and wealth management fees were under pressure due to the decline in asset values. A couple of unique items that were recorded this quarter was a BOLI gain of $5.3 million, which was offset by a write-down of an equity investment of $1.9 million reflected in other income.

Moving to Slide 16. Total expenses for the quarter totaled $96.4 million, which included merger costs incurred during the quarter of $3.4 million and severance of $600,000. Core compensation-related expenses reflected the impact of wage inflation, the success we've had filling some recent positions of some open positions recently and accruals for incentives. We also incurred an increase in marketing costs as we launched ads in the Detroit market to communicate our brand. We feel confident in our ability to realize the 30% cost savings in the acquisition of Level 1 in the fourth quarter. But going forward, expense levels will reflect our investments in people and technology. Our low core efficiency ratio reflected in the top right shows that we continue to achieve strong operating leverage even with these investments.

Slide 17 shows our capital ratios. The decline in tangible common equity ratio over the last few quarters was due to the AOCI changes I've mentioned earlier on the available-for-sale investment portfolio and the use of $79 million in cash in the acquisition of Level 1. Going forward, our strong earnings and increasing net interest income will create capital and strengthen this ratio going forward.

Additionally, given we have $226 million in the allowance for credit losses, which adds to our balance sheet safety and soundness, we feel comfortable with our current capital position. Overall, our financial results reflect strong fundamentals for the quarter, and we are very pleased with the results.

That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John Martin, to discuss asset quality.

Thanks, Michele, and good morning. My remarks start on Slide 18, where I highlight the loan portfolio, including segmentation growth and composition.

This quarter, I've included a portfolio insights slide. I will again review asset quality and the nonperforming asset roll forward before ending with a couple of high-level comments about the current environment.

Turning to Slide 18. In the quarter, excluding the $22 million reduction in PPP loans, the total loan portfolio grew $291 million or 10%, leading the growth this quarter was the addition of $191 million in residential mortgage loans. With the rise in interest rates, the mortgage team has leveraged the desire of borrowers to take advantage of the lower adjustable rate to add high-quality, primarily adjustable rate loans to the balance sheet. While lower than the second quarter, we continue to experience broad growth in commercial industrial loans, including sponsor finance as well as in the construction lending. Non-owner-occupied CRE declined with borrowers moving projects to the permanent market, while construction lending grew with new commitments and higher construction utilization, which climbed to 61% in the third quarter, up from 53% in the second quarter.

Turning to Slide 19. I've sliced the portfolio several different ways to provide additional transparency into the portfolio's composition. Starting with C&I. This classification includes sponsor finance as well as owner-occupied CRE associated with the operating business. Our C&I portfolio is representative of our markets and thus has a concentration in manufacturing. Our current line utilization is 40%, down roughly from 45%, and I provided historic utilization levels to clear any confusion from prior calls. We participate in roughly $600 million of shared national credits across various industries with an average exposure of roughly $10 million. We also have $78 million of on-balance sheet SBA guaranteed loans, which includes $11 million of remaining PPP loans.

Diving into the sponsor finance portfolio, we have roughly 60 portfolio companies. 90% of those borrowers had senior cash flow leverage less than 3x and 86% had total debt to cash flow leverage of less than 4x. 85% of those had a fixed charge coverage of greater than 1.5x, which resulted in a current portfolio classified loan ratio of less than 3% at the end of the third quarter. We review the individual names in this portfolio in-depth quarterly and monitor closely for changes in asset quality.

Moving to construction finance. We have a limited exposure to residential development and are primarily focused on 1 to 4 family non-tracked individual build development, although we have a handful of residential development relationships we continue to maintain. For commercial construction, we continue to have a bias towards multifamily construction with a sub-concentration of student housing. Moving down to consumer and residential mortgage. The portfolio consists of primarily prime originated residential and consumer loans. These include HELOCs and he loans, direct auto and miscellaneous other consumer loans.

In summary, the portfolio is a balanced mix of what one might expect from a Midwest bank with a mortgage consumer sponsor finance and investment real estate business.

Turning to Slide 20. As in previous quarters. This slide highlights our asset quality trends and current position. We continue to have favorable asset quality profile with nonaccrual loans on Line 1, down $2.5 million with other real estate 90 days past due and renegotiated loans mostly unchanged. We ended the quarter with $50.9 million in NPAs and 90-day past due or 0.44% of loans or 29 basis points of total assets.

Dropping down to classified loans on Line 7 or loans with a well-defined weakness, there was a net increase of $15 million to $207 million or 1.77% of total loans, which remains comparable to prepandemic levels.

Then finally, we had a net recovery, as Michele mentioned, in the third quarter and a net recovery of $751,000 year-to-date. In the third quarter, we had a $1.3 million recovery from a 2021 charge-off related to a senior housing relationship that helped to offset the roughly $900,000 in charge-offs.

Then finishing up on Slide 21, we roll forward the migration of nonperforming loans, charge-offs, ORE and 90 days past due. Nonaccrual loans fell $2.5 million on Line 6 with the resolution of a grain marketing company from a prior period, offset with the addition of a $4.7 million Serie housing relationship that entered the category in the quarter. Given the current environment, we've been able to balance the migration of new nonperforming loans against the resolution of existing nonperforming loans with $2.5 million of improvement in the quarter.

With respect to ORE and charge-off, we had nominal change in ORE with the largest beating a 5-point, -- this the largest in the portfolio being a $5.8 million student housing project with $900,000 in gross charge-offs and no other significant changes, we ended the quarter with $50.9 million of nonperforming assets and 90 days past due on line 14.

In summary, our asset quality position is strong and continues to remain stable, providing a little more color, I regularly attend top borrower relationship review meetings and can see the effects from higher interest rates firsthand. While having an impact, interest rate stress built into our underwriting and the borrower's ability to adjust either or both pricing and expenses has buffered much of the increase.

We continue to closely monitor the portfolio to ensure timely issue identification and implementation of risk mitigation strategies.

I appreciate your attention, and I'll turn the call back over to Mark.

Thanks, John. We followed a recommendation that Terry McEvoy had and Terry, I know you're on the call. Thank you. I hope our analysts and investors appreciate the additional credit slide that you included, John. I think it addresses some of the areas that maybe cause some cause for concern in the industry, not specifically first merchants. In this environment, investors, they're always looking for more information and concerned about what they don't know. What we clearly believe is that we have a very balanced granular portfolio where underwriting and managing risk are they just always work in conjunction with our sales teams. We believe that our healthy level of reserves and low levels of NPAs are a critical part of our strong investment thesis.

Slide 22 highlights our track record of performance. And on Slide 23, you'll see it highlights our combined annual growth rate for assets, both organic and through M&A, which includes 9 additive acquisitions since the great recession. It's probably a good time to talk about M&A. I'm proud of our M&A capabilities. However, I'm truly looking forward to solely focusing our teams on internal efficiencies to improve processes, procedures and technological enhancements while strengthening the customers' user experience in 2023.

Slide 24 is a reminder of our vision, our mission and our team statement and the strategic imperatives that guide our decision-making. I'm confident that when you look at our results to include strong organic growth, balanced with conservative underwriting standards, healthy reserves and capital, powered by strong operating leverage or a strong pretax pre-provision earnings, you will see a company's scorecard that aligns with its healthy culture. We know who we are and what we stand for and our strategic imperatives drive our decision making.

Thanks for your attention and your investment in First Merchants. And Michelle, we are happy to take questions at this time.

(Operator Instructions) Our first question comes from Scott Siefers with Piper Sandler.

Either Mark or Michele, was curious if you could address the expense topic. I think their core expense base came in higher than you guys had suggested last quarter. I certainly see the drivers in terms of marketing and compensation costs. But how much of that total level is now sticky? Or could it come down on a net basis? I think you guys had previously been saying closer to like an $84 million level as the Level 1 costs came out, but we're sort of a far cry from that now. Just curious to hear what the appropriate basis that we should be thinking about and where it could go from here?

Yes. We had some onetime items that we recorded this quarter. I highlighted a couple of those for you. And so when we look at fourth quarter expenses with inflation and some of the investments that we've made, we also increased minimum wage to $16 an hour. So I think fourth quarter expenses could come somewhere in the range of $89 million to $91 million.

Okay. Perfect. And then you gave some color on NII tailwinds as we go forward. I guess once the Fed stops raising rates, we'll certainly have the cash flows from the securities portfolio, but of course, presumably deposit betas will begin to catch up. What's your confidence in First Merchants' ability to continue to grow NII sequentially once the Fed stops raising rates?

We've got a pretty significant portion of our variable rate loans that reprice in the first year. So even once the Fed stops raising rates, we will see lift in interest income over the course of the year. The deposit competition and how quickly betas rise, that remains to be seen. I do think that we'll see deposit betas get back to historical levels through the cycle. But we do think that we'll see net interest margin lift over the next couple of quarters.

Yes, Scott, and we've always been confident that even when the Fed stops that our organic growth rates continue to remain strong and help us power through in terms of earnings.

Our next question comes from Daniel Tamayo with Raymond James.

Maybe we could talk a little bit about the fee income outlook. You touched on the overdraft impact in deposit service charge. Obviously, mortgage banking has come down and then you talked about the amount being sold in the market relative to what you're keeping. You've seen some nice resi growth there on the balance sheet. But overall, kind of the number looked a little bit lighter than I was expecting, I guess, pulling out the BOLI gain and the corresponding hit there. How are you thinking about where fee income could shake out here in the fourth quarter?

I think these are levels that you can anticipate going forward. And we've always viewed our noninterest income to be driven off of our core customer base. But it's also always been a real hedge in terms of just interest rates. And when rates rise, our noninterest income typically isn't as strong. And when rates start to go the other direction, our fee income helps pick us up. So these levels, we're not excited about where we are today, but it is consistent with what we expect when you have.

Okay. And then I think you just mentioned that you're continuing to expect pretty good growth. I think that was meant on the loan side, but maybe just kind of talk a little bit about what you're seeing -- what you're expecting on the loan growth side. I'm assuming that the residential mortgage growth will slow here with rates up and perhaps selling a little bit more of that production. But curious where you're seeing the growth on the loan side and what kind of growth you're expecting is maybe demand slows with rates being up here?

Yes. I'll just say that our guidance of mid-to-high single digits is kind of -- as always, the objective. We've had a little stronger year this year because of the mortgage activity and our willingness to use our balance sheet we're actively looking for additional sources to sell the 5 and 7-year arms because there's only so much balance sheet capacity we can commit to mortgage. So it's been a really nice add to our growth in 2022. I don't see it continuing at the same level. Although I do feel great about our production and the quality of the team, we're looking for secondary source to sell into the market. The real core of our growth is going to come out of the commercial balance sheet, and Mike mentioned our pipeline. I'll let him maybe touch on some of the areas where he feels best.

Yes, I did highlight briefly. Daniel, that our commercial pipeline at the end of the quarter is really strong. And if you watch this over time, you can see that kind of predicting that the outlook quarter-to-quarter can be a little bit choppy. But when you look at it over a continuum time, that's why I feel always confident on that high single digit. We had a really strong second quarter, and we had a good third quarter here, but the pipeline makes me feel like the fourth quarter will finish out strong, and it's due to, I think, some of those things I was trying to highlight, which is businesses are finishing their capital plans, preparing themselves for 2023. They're preparing for the continued working capital increases that they still see coming down the pipeline. And now we've got a broader market, as you know, in that the Greater Michigan marketplace that we haven't really fully penetrated yet. So I do think that, that the C&I, real estate commercial will be the continued driver of our balance sheet is the biggest part of it as well.

That's helpful. And then lastly, I guess, just kind of following up on the NII growth question earlier, but looking at it from a different perspective, you talked about cash flow securities funding loan growth to a larger stent in the third quarter and still having an ability to do that going forward. How are you thinking about the willingness ability to be able to do that? And then as it relates to the growth of the overall balance sheet, what are you expecting there?

Yes, I'm not sure I fully follow. I think you're just talking about the capacity to fund. Is that what you're -- is that where you're going, Daniel?

So essentially, like if you're going to be mixing -- continuing to remix the balance sheet from funding loan growth from security maturities if the balance sheet is expected to remain relatively stable going forward?

Yes.

Yes, I think our balance sheet will continue to grow. The securities balances, they will decline some as we cash flow that portfolio. But I think the loan growth will -- as Stu said, will be in the mid- to high single digits. And so that will drive balance sheet growth overall.

Yes. And we are expecting loan-to-asset ratios to increase as well as on the deposit ratios.

Our next question comes from Damon DelMonte with KBW.

I hope you guys are doing well today. So my first question, just on the outlook for the provision. I know you guys have been kind of growing in our reserve levels over the last few quarters and not been booking reserve. Just kind of with the growing concern for deterioration with the broader economic outlook, could you just kind of give a little update as to where you think a reasonable reserve level would be to settle in at?

Yes. Our reserve levels are still pretty robust. And so we feel like we've got great coverage heading into this uncertain economic environment for kind of whatever it brings our way. So I'm not expecting to need to take any additional provision over the coming quarters. I think that we've got -- I think Del just got ample coverage today.

Okay. That's great. And are there any like segments of the economy or areas in the portfolio where you're kind of pulled back a little bit out of concern of storm clouds on the horizon.

I would answer Damon, not really, no. The higher interest rates have economic impacts to projects and the borrowers may have less demand going forward. But from our willingness, Stu mentioned it earlier, earlier, it's a consistency of underwriting. So it's not that we're pulling back. It's just where there is demand in the portfolio given the static underwriting.

Got it. Okay. That's helpful. And then, I guess, lastly, just to kind of circle back on the margin. I appreciate the commentary and color on the outlook. But just wondering from like a cadence standpoint, Michele, pretty sizable increase this quarter. I think it was like 27 basis points linked quarter. How do you feel that the upward trajectory goes over the upcoming quarters? Do you think you could repeat something like this level? Or do you think it kind of starts to moderate?

Yes, I think it will moderate. Our deposit beta was only 20% this quarter, and I do think that will creep up as the competition for deposits grows. I would think in -- if we assume a 75 basis point increase in November and another 50 in December, we think we would get another 15 basis points of margin lift, assuming -- and that assumes that our deposit betas start to increase a bit and then maybe another 10% in Q1, another 10 basis points lift in NIM in Q1.

Our next question comes from Terry McEvoy with Stephens.

This is Brandon Rud on for Terry. I just have one question. Most of the other ones have been answered already. But pertaining to capital, you CET1 of 10.4% this quarter. Can you talk about your thoughts on capital management and potential opportunity for share repurchase going forward?

Yes. Our capital levels right now, we're really pleased with where we're at and that we don't anticipate doing share repurchases in the coming quarters.

Our next question comes from Brian Martin with Jamie.

Just wanted to touch base just a couple of kind of housekeeping questions. Just as far as the deposit growth or just the shrinkage this quarter, just given the environment out there, just kind of wondering your outlook on the deposit side and just how you're seeing -- what you're hearing from your customers and the expectation for growth there prospectively or just more stable? Just how you're thinking about that.

Yes. We expect it to really be more of a stable environment. I mean we'd love to see some growth just about a pure activity, all the work that we're doing. But the interest rate environment and our management of that cost are I mean they hold growth back some. But we just think it's a nice balance between making sure that we're not overpaying and we're still adding relationships, which the teams are doing every day.

Got you. Okay. And then maybe just on the deposit side, Michele, I think you said you're kind of 20 now. Just as kind of where are you thinking that heads to if you get kind of the increases you outlined there, maybe a 75% and 50% mean, you get into next year, just later this year, that deposit beta, what would you expect kind of creeping up to?

Well, in the last cycle, we had a deposit beta of 41%. And I think through the cycle, by the time we get to the end of the cycle, we'll probably hit that deposit beta again. But how quickly it rises, it just kind of remains to be seen with competition for the NIM over the next quarter or 2, we've been modeling a 25% deposit beta, so up about 5% from where we're at today.

Got you. Okay. No, that's helpful. And just the -- maybe 2 last ones. Just on the utilization was a little bit lower this quarter. Is that -- is there any just lumpiness in that? Is that how to read that? I mean, the trend has been a little bit different, but just want to see if there's anything that would easily explainable -- or is it just going to be a little lumpy is that how you guys would think about it?

There's 2 things. And Sue's got some thoughts as well. I would say that the first thing is that Level 1 had a 34% utilization rate. And when those commitments were added in the third quarter to our reporting databases it drove down from 44% to 40. So there's a little bit that showed in the quarter. It's just as well as just paydowns from the balances for people holding cash. They find it favorable to pay down their lines over keeping cash in the your checking account. So a couple of factors there that I think contributed to lower utilization.

And even the legacy First Merchant portfolio utilization went down very little, but it went down, just kind of interesting phenomenon to say the least. And I just attribute that to we got really smart business owners that know how to manage working capital cycles. They're keeping their working capital at a really good pace. When you think about the growth that's happening with just inflationary pressures that go that drive up inventory that then drive up their receivables, but yet they still have ample liquidity for that. We're not seeing slowness in account receivable collections. We're not seeing still inventory. So it's really -- it's to me, just another observation of a pretty strong business community. Got you.

No, that's helpful, Mike. And maybe just one last one was just on the tax rate. Just how to think about the tax rate, either next quarter or kind of into next year. It seemed like it was a little bit lower than I thought this quarter. Maybe I was incorrect in that, but just how to think about that.

Yes, the tax rate was a little lower this quarter because of the BOLI gain that it's tax exempt. And so I would say an effective tax rate going forward to be about maybe 14.5%.

At this time, there are no other questions. I would now like to turn the conference back to Mark Hardwick for closing remarks.

Thank you, Michelle. Thanks to all of our participants for joining the call. We had a great quarter. We're really excited about what the future holds and just look forward to your continued investment. Thank you.

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