First Merchants Corp (FRMEP) 2007 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the First Merchants Corporation second-quarter earnings. (Operator Instructions). As a reminder, this conference is being recorded.

During the call, we may make forward-looking statements about our relative business outlook. These forward-looking statements and all other statements made during the call that do not concern historical facts are subject to risk 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.

It is now my pleasure to introduce your host, Mr. Michael Rechin, Chief Executive Officer of First Merchants Corporation. Thank you, Mr. Rechin. You may now begin.

I appreciate all of you on this call for making the time to follow our progress here at First Merchants. Joining me today are Dave Spade, our Chief Credit Officer, who will remark later on the condition of our loan portfolio and on our actions to manage our credit quality. Also joining me is our CFO, Mark Hardwick, who will follow me with a review of our financial results through June 30.

My comments in our release speak to our results for the last three months. In the second quarter, we recorded net income of $6.2 million, after absorbing the unamortized issuance costs associated with our July 2 trust preferred refinance and other onetime expenses shared in public releases earlier this year. The refinancing benefit is significant to us and provides a six-quarter payback on the charge as indicated in our second quarter. Our normalized year-to-date earnings equals $0.84 per share, a 5% increase over the first two quarters of 2006.

During the quarter, we continued to build our earning assets and were encouraged by the results you can see in our customer acquisition, both in our banking and non-banking businesses. We managed to keep our bankers focused on the needs of our customers while completing significant work in building our brand.

At this point, I'm going to ask Mark to provide a more thorough discussion of our performance.

Ladies and gentlemen, we appreciate your time this afternoon. The corporation's assets totaled 3,670,000,000 as of June 30, 2007, an increase of 261 million or 7.7% over the prior-year period. Total loans increased by 8.3% or 214 million. Commercial and industrial loans led the corporation's loan growth by increasing 89 million, or 17.8%. Commercial real estate loans paced second as this category increased by 82 million or 10.1% over last year.

Billable investment securities and bank-owned life insurance increased by 12 million and 25 million respectively. Total deposits increased during the last 12 months by 184 million or 7.3%. We're pleased with the growth of both our loan and deposit categories and expect to continue the current run rates for the remainder of the year.

Our year-to-date net interest margin has obviously declined significantly over the last year given the flatness of the yield curve, as has most everyone else in our industry. However, the decline in margin has stabilized over the last four quarters. To evaluate our margin, we need to adjust for this quarter's special charge related to the early redemption of our trust preferred securities as detailed in our press release.

The early redemption of our fixed-rate 8.75% trust preferred securities require the corporation to accelerate the recognition of the remaining unamortized underwriting fee of approximately 1.8 million during the quarter. That adjustment of 22 basis points results in linked quarters of 3.66, 3.54, 3.5, and 3.5%, demonstrating some stability of net interest margin. Additionally, when considering the carry costs of 25 million of bank-owned life insurance and the increases in our non-accrual assets, which have negatively affected margin by 8 basis points. The corporation actually regained some margin over the last several months.

The refinance of our trust preferred securities will save our shareholders 225 basis points on 53 million of outstanding debt and will add the margin throughout the third and fourth quarters of '07. We're confident that our current margins will allow the corporation's run rate related to loan and deposit growth to be more positively reflected in net interest income on a go-forward basis.

Loan loss provisions for the year and quarter equal 23 basis points, consistent with the corporation's annual 2006 provision expense of 23 basis points. Net charge-offs for the year totaled 16 basis points, 3 basis points more or actually 3 basis points less than last year's first six-month results.

Nonperforming loans increased to 1.39% of average loans for the quarter. Mr. Spade will detail the changes in our nonperforming loans from year-end and will explain our position and our plan of action at the conclusion of my comments. But I would like to point out the fact that of our 27.6 million reserve for loan losses, just 6.8 million or 24% is reflective of specific reserves attributable to our nonperforming assets.

Non-interest income, on a very positive note, continues to grow at a high rate. The year-to-date increase of 2,562,000 or 15.1% comes from several sources, including service charges on deposits, accounting for 777,000, earnings on cash surrender value of bank-owned life insurance 612,000 and insurance commission increases of 457,000. Year-to-date operating expense absent the 601,000 related to the operational conversions increased by 1,879,000 or 3.9%, including increased FASB 123 expense of 389,000 for the year and continued investment in sales talent. As detailed in our news release, adjusted diluted earnings per share totaled $0.84, a $0.04 increase over 2006 first-half earnings per share of $0.80.

Now, Dave Spade will supply you with the necessary information required to understand the specifics of our increased nonperforming loans.

Our commercial credit focus is certainly to reduce the nonperforming assets with several different strategies, including an asset sale in the secondary market, expected payoffs from borrowers who have identified buyers for their properties and through aggressive special assets efforts to move credits out of our banks. During the second quarter, First Merchants Corporation had an $8 million increase in nonperforming assets, essentially in two names made up in this increase. One was a commercial development in Delaware County in Eastern Indiana, and one was a residential land development loan in Tippecanoe County in Western Indiana.

FMC is in the process of offering a pool of loans in the secondary loan market. These loans represent both performing commercial loans in a substandard category and loans that are nonperforming. The underlying collateral valuations are reflective of the corporation's specific reserves that Mark mentioned a few moments ago.

FMC anticipates reasonably strong bids for these assets that are going to be shown to the market with very manageable financial impact. Of our overall delinquency percentage, corporate-wide, for all types of loans, only 1.21% of total loans are past due 30 days or more. That represents 1.8% of our retail mortgage loans, 0.91% of commercial loans, 2.22% of consumer installments, and 1.79% of home equity products.

First Merchants Corporation has many loans that appear in the nonperforming classification that are current with respect to the scheduled principal and interest payments. The corporation's classification in nonperforming is frequently based upon our cash flow analysis that show weaknesses in the borrowers' debt service coverage.

Before we open the lines for questions, I would like to touch on just a few additional accomplishments of our employees. In April and May, we completed the legal aspects and re-signing involved with merging five banks. Our communication plan to our customers and our employees was comprehensive with a virtually complete retention of those customers. Later this quarter, we will be surveying those folks all over our franchise relative to the quality of our service.

Our branding efforts will continue beyond the bank name changes to broaden our presence throughout our footprint. Also consistent with our plan for 2007 is the completion of the merging of databases associated with the charter merges last quarter. At this point, we're approximately 50% complete with that work and anticipate 100% completion early into the fourth quarter.

Our model continues to emphasize local market autonomy, credit decisioning and market tactics. We've installed new line of business incentive plans that appear to be providing the lift and measurement consistency we've targeted.

At this point, Operator, if you could open the lines for questions, all three of us would be glad to respond.

(Operator Instructions). David Scharf, FTN Midwest Securities Corp.

I was hoping we can kind of touch on some of the remaining expenses associated with the merged charters. Is it fair just to take the remaining 400,000 and break them up equally over the last two quarters?

This is Mark. I think that is the perfect way to look at that as you're trying to understand. Our year-to-date and quarter 600,000 of the expenses were all expensed in the second quarter. But on a go-forward, the remaining 400, we do expect to see recorded equally over the third and fourth quarters.

This question is probably good for David. But I was a little confused when you talked about [1.4] and 2% of loans are 30 days past due. Is that just a 30 to 89-day window or does that also include the 90-day past due that's still accruing?

That would include every loan except non-accrual loans.

So it does include the 5.2 million?

That's correct.

And Mark, you talked about margin stability going forward. Is that -- what do you think is driving that?

Well, I feel like we've really just hit the low point. I mean we had an aggressive increase in the Fed funds rate that stabilized at 5.25. We have had to manage some of our deposit cost up as the short-term rates have increased. I feel like we've really just watched that stabilize over the last three quarters, the fourth quarter first and then second quarters of this year. And given where we are today in the yield curve, I don't see any additional pressure on our net interest margin, nor do I really see a lot of relief either. I think we've just hit a normalized spot in the 350 range.

David, it's Mike Rechin. I would also add that we had spoken earlier in the year about pulling back in some of our lowest yield asset generation activities, specifically the non-relationship activities of indirect lending, which we haven't exited but we've cut back substantially.

Mike, could you comment on sort of the pockets of -- or the -- looking out at the franchise, where you're finding the most loan momentum and talk about the pipeline and just go ahead and give us a little more clarity on what to expect over the next maybe six months?

Sure. We really have for the first time consistent year-over-year commercial pipeline numbers that we rely on as we look to fund our balance sheet as far forward as we can reliably see it. And those numbers would indicate that we are about 5% over the same time last year, June of '06, and up a little bit less than that, 3% or so over 60 days ago. That is somewhat encouraging because we are pleased from the commercial run rate of the activity that we've seen and won in the market.

In terms of where it's coming from, it's fairly broad-based. The diversification of the portfolio has us growing our C&I lending at a rate that I am pleased with. There is a lot of commercial real estate activity out there and we have partaken in that. Certainly in our most urban markets of Columbus and Indianapolis but really throughout, we also benefit from the ag economy on the east and west sides of the State of Indiana, which can -- based on that market and that industry has been strong over the last two years.

I will hop off for now and I will have a follow-up if nobody jumps on.

(Operator Instructions). David Dusenbury, Dalton, Greiner, Hartman.

Could you talk a little bit about your -- the credit picture in terms of criticized assets or special mention assets and give me a sense for how that has looked quarter-to-quarter, what the flow looks like, any addition -- where you're seeing the increase in what buckets?

Thanks for that question. Our increases in special mention loans certainly have increased. Although, we see that lesser increase than we had our substandard and other classified loans. We're pretty close to target numbers on those special mention loans, but still a component that we are working hard with our special assets people and our bankers to reduce.

Our nonperforming again relate to a couple of particular names. We see some opportunities based upon current information to get some loans paid off by our borrowers because they have identified sellers -- buyers that will purchase those loans or those properties. So, we've seen pretty much a stabilization of some of that.

But I'm not sure if you've got any specific questions I might answer. I may not be hitting on everything that you want.

That was kind of a broad question quite honestly. But the -- if you could, the loans where you feel that the borrowers could pay them off or was it that you think the borrowers can get them -- can pay them off or that you can have them sold?

We're going to do both. We've got a loan sale of a pool of loans and we have some customers that have identified some people that will purchase their assets. So, our trend and our criticized has been fairly stable from 9/30/06 through the current quarter, and those are ranging at about 45 to 46% of total bank capital.

Criticized assets to total bank capital. So, if your question is, is our overall pipeline while the non-performers have risen, is the pipeline behind it growing also? It doesn't appear to be.

That's it. That's kind of what I was driving at in an obtuse way; I apologize. In terms of the pool of loans, where are you in that process? Is that something you think you can close in the next quarter or so?

Yes, we definitely expect to close those opportunities within the month of August, if not early September.

Brian Martin, Howe Barnes Hoefer.

I wanted to just get two things. I joined a little bit late, so I may have missed this. But your -- the formation of the REIT structure and the tax change in the quarter relative to last quarter, can you just give a little color on what your expectations are as far as improvements to that rate as you look to the second half of the year and maybe what type of improvement you saw out of it this quarter, if you can quantify that somewhat?

Yes, I can. We actually deployed the REIT a little later than we had originally anticipated. We only recognized in the second quarter about $60,000 worth of benefit. And as we move through the remainder of the second half, we are adding additional assets to the REIT. We added originally 209 million. Tomorrow actually, we're closing a transfer of another 186 million into the REIT. And those transfers are in connection with the consolidation efforts that we have with the five banks merging into one.

So, our intentions for the second half of the year are to leverage the REIT a little more than what it would require for an annualized run rate, so anticipating somewhere in the range of a $360,000 benefit on a quarterly basis in the second and third quarters. And if we're able to move enough of our real estate assets in that we could better that number. But that's our target for now.

Just secondly, touching on the credit side, the two relationships that came on-board you talked about this quarter, outside of that, can you just refresh our memory as far as some of the other larger credits within that group of 30 million or so as far as size and maybe just geographic concentration and then the component, whether it's C&I type of stuff or commercial real estate of those larger credits?

There is no geographic concentration. The largest non-performer outside of the two we added this quarter would be actually C&I credits, one of them in Columbus, Ohio and one here in the Muncie region. Don't have any in large concentration to sub prime lending at all. And the balance of the commercial portfolio if there was a common thread, it would be investment real estate oriented.

The size of those credits, what -- when you dropped down to the two you added this quarter, what type of size range are you looking at as far as those -- the next group down as far as how big they are? In this one in Columbus or in Muncie, can you give us any sense for how large those are?

This is Dave Spade. Probably the next largest borrower is in the $2.5 million range, and the other non-performers over 250,000 drop pretty quickly to ranges of less than 1 million. We have about 32 names in that category.

And just -- I guess talking about these loan sales and the level of criticized and classifieds not changing all that much. Your sense for what type of charge-off activity you see over the next six to 12 months, is there any concern that that number runs -- has some significant volatility to it or is it -- you expect much of what we've seen recently?

This is Mark. We feel very confident about our problem loan update process where we are discounting collateral values, discounting cash flows and identifying the specific reserves required on each of our nonperforming assets. And those were referenced in my comments during the call as being 6.8 million in total with a reserve of 27.6 million.

So, if there are additional charges through the loan sale, it really in our mind and our assessment as we've laid this process out throughout the last couple of months, is that there is typically some discount just to move the assets off the book quickly versus holding them on our books and working through them over time. And obviously there's some financial benefit on a go-forward basis to having our cash in-hand early.

So, we don't have a -- an anticipation of significant charge-offs as we move through the second and third quarters that would require significant provisioning. We feel like we have a good handle on asset quality. And we will obviously readdress the position of our allowance as those loan sales would conclude. But, at this point, we don't have a big concern over that as we move through the rest of the year.

Just lastly, the recent acquisition activity in kind of the Indianapolis market, can you just comment on that relative to if that's a -- just given your expectations that you guys are in that market, do you see any big lift coming out of that or is it as far as maybe hiring some people or gathering a little bit of momentum down there? And maybe you can comment just on the size of where the Indianapolis portfolio is currently.

I would be happy to. Brian, it's Mike. Our portfolio in Indianapolis is just over $200 million in outstandings and closer to $0.25 billion dollars in commitments. It's growing really somewhat nicely. It's about a three-year-old effort.

In regard to the Indianapolis market place overall, I think any ownership transition can present disruption. But we don't really look to that to accelerate our progress. We like to have a consistent approach driven through commercial bankers that target customers we think whose needs fit what we can provide. If anything, the recent activity that took place there just emphasizes to us the value of franchises that have meaningful share in that market. It's one of the reasons we think that our value proposition to clients continues to fit well.

And lastly, that 200 million that it's at right now, can you give us some idea of what it was at six months ago or a year ago if you have that number?

I will give you a ballpark number that I think is very good. It's grown about $40 million this year and I think it grew about $50 million all of 2006.

(Operator Instructions). Gentlemen, there are no further questions in queue at this time.

Well, again, I appreciate the participation of everyone on our call today and hope to see many of you in Chicago in mid-August at the upcoming Howe Barnes Conference where we'll be presenting and appreciate your time again.

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.