First Merchants Corp (FRMEP) 2007 Q3 法說會逐字稿

Greetings, and welcome to the First Merchants Corporation third-quarter earnings conference call. (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 services industry, the economy, and future growth of the balance sheet or income statement.

It is now my pleasure to introduce your host, Michael Rechin, CEO. Thank you, Mr. Rechin. You may now begin.

Thank you, LaTonya. I appreciate all of you on this call for making the time to follow our progress at First Merchants. Joining me today is our CFO, Mark Hardwick, who will follow my remarks with a review of our financial results through September 30. And also with me is Dave Spade, our Chief Credit Officer, who will remark on the condition of our loan portfolio and our actions to manage our credit quality.

My comments in the release speak to our results for the last three months, and I think you can see that in the third quarter, we recorded net income of $8.35 million. During the quarter, we continued to build our earning assets, and were encouraged by our rate of customer acquisition in our banking and nonbanking businesses.

Our loan growth has come from throughout our footprint, but most prominently, from our Indianapolis; Columbus, Ohio; and Muncie, Indiana regions. Our insurance unit and trust company also show consistent revenue and profit growth, and contribute significantly to our non-interest income growth. Considered as a whole, all seven of the specific line items comprising our non-interest income section in your income statement enjoyed strong quarters.

Our execution in the field remains centered on local market autonomy, including credit authority and community involvement directed at increasing our customer satisfaction and building share.

At this point, I have asked Mark to provide more detail in review of our financial statements.

Thank you, Mike. Ladies and gentlemen, we appreciate your interest in First Merchants this afternoon.

As Mike mentioned, our third-quarter earnings per share have increased 9.5% to $0.46 per share, allowing our year-to-date earnings per share to equal our 2006 result of $1.22. The Corporation's assets totaled $3.754 billion as of September 30, 2007, an increase of $282 million, or 8.1%.

Total loans increased by 8.6% or $228 million, as linked quarter-over-quarter loan growth percentages continue in the high single digits for the seventh consecutive quarter.

Commercial and industrial loans lead the [Corporation's] growth by increasing $129 million or 26%. Commercial real estate loans placed second by increasing $77 million or 9% over the last year. Strategic runoff is also noticeable in our loan summary on the last page of the earnings release, as loans to individuals for household and other personal expenditures declined by $21 million or 9.8%.

Total investment securities and bank-owned life insurance increased by $6.5 million each. And total deposits increased during the last 12 months by $65 million or 2.4%.

Keeping up with our loan growth is proving to be more of a challenge in late 2007 than it was in 2006, when we were growing the advantage checking areas of our balance sheet quite well through public fund non-profit sales efforts.

Our year-to-date net interest margin decreased by 27 basis points or $0.20 per share through nine months. However, our net interest margin has stabilized over the last four quarters. Our linked net interest margin has been 3.54, 3.50, 3.50, and 3.52, and we expect the fourth quarter to be within the same range as the structure of our balance sheet slightly favors falling interest rates.

Loan loss provisions for the quarter totaled $2.8 million or 40 basis points, an increase of $1.3 million over the same period in 2006 as net charge-offs totaled 39 basis points for the quarter.

Through the completion of a loan sale and ongoing internal workout procedures, the Corporation did remove $7.2 million from our nonaccrual totals during the quarter. However, an additional $6.5 million were added to nonaccrual status during the same time frame. Linked nonperforming assets as a percent of average loans declined from the second quarter total of 1.39% to 1.25%. Dave Spade will provide the needed color on the turnover of our nonperforming loans in just a moment.

2007 is proving to be a year with many ups and downs, and has created a sense of mixed emotion. Given the reductions in net interest margin of $0.20 per share; the refinancing charges related to the call of our trust preferred securities of $0.06 per share; additional provisions totaling $0.03 per share and restructuring charges related to the five data consolidations costing $0.02 per share, the expectations might be that we would have -- that we would be having a down year.

We have managed to make up the $0.31, and reduce net income through revenue growth and tax strategies. The 8.6% increase in loan growth, as previously discussed, is the key driver. And a close second is our $4.6 million increase in noninterest income. This increase reflects a number of our 2007 strategic initiatives that have produced positive results, including $963,000 of increased service charges on deposits; $891,000 of improvement in the cash surrender value of bank-owned life insurance; a $663,000 increase in insurance commission income; and a $515,000 increase in trust fees or fiduciary activities.

We continued to leverage our infrastructure as our growth rate of expense remains in the low single digits at 4.4% for the quarter and 3.8% for the year, absent the non-recurring expenses from our debt refinance and data consolidations events totaling $2.5 million.

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

Thank you, Mark. We continue to have our focus on the reduction of nonperforming assets, with strategies to include aggressive collection, sales in the secondary market, and other payoffs of troubled loans through the normal course of business. In fact, we've had several borrowers who have identified buyers for their real property and other assets.

Totally, our nonperforming assets fell by nearly $3 million at the end of the third quarter compared to the balance reported at midyear. 90-day past due loans and nonaccrual loans were categories that were reduced the most.

There was only one large loan that transferred to a nonperforming asset category during the third quarter, much less than what we experienced between the first and second quarters of 2007. That loan is actually a $1.4 million commercial real estate facility, and there is now an offer to purchase which has been accepted by both the buyer and the seller.

We offered to pool loans earlier in the year -- actually, in September, through the secondary market. And that consisted of both performing and nonperforming assets. Based upon bids for the loans that were offered, the Corporation did accept $4.1 million for those outstanding loans. Any residual balance after the sale was completed was charged then to the provision by the end of the third quarter. We will continue to look at that strategy as one tool to reduce our nonperforming asset totals.

Of note is the fact that the top 10 special mention loans are current and accruing interest, and that 14 out of our top 20 classified loans are current and accruing interest.

The Corporation's 30-day delinquencies were 22 basis points less on September 30 compared to the totals on June 30, 2007. The total past due accounts were listed at 54 basis points of total loans at the end of the last quarter.

We have actually seen over $2 million in actual payoffs or commitments for payoffs of the nonperforming assets since the first day of the fourth quarter. We expect that trend to continue. We have three other large troubled credits that have the potential for takeout within the final quarter of 2007 or into the first quarter of 2008.

Dave, thank you for your remarks. Before we open the lines for questions, I would just share an additional thought. Earlier this year, we completed the branding and signage changes associated with combining five bank charters. Our employees really performed superbly through that effort, delivering on our high-touch community bank service commitment. By the end of next week, our database merging associated with that work will also be complete.

To gauge our process, we surveyed 2,000 households in late summer, and were pleased with the results, confirming our bankers are providing consistently strong service and meeting needs. 94% of our respondents told us they were satisfied or very satisfied, and 88% -- they would provide referrals to the bank.

Lastly, we are near the end of our planning cycle for 2008 where our primary thrust will be to look to optimize our performance based on the initiatives we've been executing on this year.

At this point, operator, I would ask if you could offer instructions for our ability to take questions.

(Operator Instructions). David Scharf, FTN Midwest Research.

I was wondering if you could give us a little insight into the loan pipeline and also what areas, as far as geographical area, are driving some of your loan growth right now?

Relative to what's on our balance sheet in terms of the areas that have driven it, I think you'll see as we have seen over the last several quarters that our loan growth is coming out of our more metropolitan areas that we serve that happens to coincide with where we have been adding our investment and relationship managers.

And so, to be more specific, I would tell you that our Indianapolis market, which is an effort that's three years old and is accompanied by five banking centers, has grown $70 million from the front of the year, from December 30 through the end of the third quarter by $70 million net, and $100 million from this point of last year.

Our Columbus, Ohio effort, Commerce National Bank, continues with their commercial effort in a strong way, and are up $60 million year-to-date and $85 million from 9/30 of last year.

We are pleased this year, we have been getting some lift in Muncie, our headquarters market, that had a very strong third quarter -- just out of a little bit of work out of the core business itself, where C&I has picked up a little bit, and our efforts up north of Muncie, up to and include the south end of Fort Wayne.

Our pipeline is static. It actually has ticked down mildly in the last month. And it's been strong throughout the year. And if you think about how a [tool] like that would work, David, we would typically see a high pipeline level accompanied once it's closed to reflect itself on the balance sheet. And that's consistent with what we've seen.

How are the corn prices affecting or the agricultural market up there?

It's very helpful. In some regards, it hurts our balance sheet, in that the stronger cash flow into the farmer means lesser borrowing from us, and the seasonal build that we would see, we might not see. But as you know, that's a cyclical business that has had some deferred CapEx. So we are hoping that more robust cash flow in the ag business allows them all to reinvest in their businesses. And we might pick up some demand, or -- either loan demand for CapEx or deposits, either of which in the servicing of those customers we would be pleased with.

Is that a spring event, or is that more of a winter -- or late winter event?

Well, if we were going to see seasonal borrowing, it would be now. And that is a little bit down. But we are happy that the profitability of the farming business gets a little wind behind it.

David Dusenbury, Dalton Greiner.

I had a question on the nonperformers. You had mentioned your largest credit that went in this quarter was -- how large was that again?

It was $1.4 million.

And then did you say that you have interests on that property already?

Yes, the buyer and the seller have negotiated an offer, and it's been signed by both parties. So, we expect to be moving toward a closing on that credit. But we had moved it into non-accrual, albeit during the third quarter. But again, with that sale opportunity, it's going to come out hopefully during the fourth quarter, but if not, the first part of 2008.

What will that mean to you in terms of charge-offs?

We're not going to have a charge-off on that one.

That's great news. And then you are looking at some of your criticized assets. You characterized it a little bit by talking about your top 10 mentions. They are all accruing.

Yes. Top 10 special mentions are fully accruing.

As far as the flow into that bucket during the course of the quarter, what did that look like?

There were some additions. We didn't have a lot as a result of examinations or internal loan review. But there was a grouping of smaller credits, smaller business credits that we're working with aggressively. Most of those are secured. So I don't see any significant additional risk of asset decline for some of those credits.

David, it's Mike Rechin. In working with David Spade on the loan portfolio, we have a heightened sensitivity to the condition of our consumer customers. And we definitely saw a spike through the year and in the third quarter. If you look at some of the replenishment of the nonperformers that went in offsetting the $7 million that we exited, we did see an increase in what I would call smaller-dollar loans -- $100,000 and less coming out of large installment loans and small-business loans.

Okay. So as I step back and look at this quarter in terms of the size of the provision and then the size of the charge-off, compared to last quarter, should I be using this quarter as a basis off of which we grow from here? Or should I be using last quarter's provisioning levels and charge-off rates -- just from a modeling standpoint?

This is Mark Hardwick. I think that the additional provisions of $1.3 million are -- this was an aggressive quarter for us, completing the loan sale and aggressively trying to move some assets off the balance sheet. I would anticipate an increase from where we were first and second quarter, but I don't anticipate that we will have a fourth-quarter provision quite as high as what we had in the third quarter.

So ultimately, for us, it is dependent on the assessment of every problem asset; the specific losses that we have in every one of those problem assets that will be identified by the end of the quarter, and using our allowance for loan loss methodology, with an eye and an understanding that a 0.96 allowance for loan loss doesn't allow significant cushion to absorb additional credit. So as we're moving forward, we are looking at those very closely, evaluating our loss, and stepping up to the plate as far as the provisions that are required.

Brian Martin, Howe Barnes.

Just a quick question. On the loan sales you talked about a little bit and the improvement in the credit side, can you talk about the improvement -- as you look to the fourth quarter and even into '08, do you think -- if you had enough interest on the loan sales, that you might be able to see more of those? Or do you think it's more going to be working them out or just kind of pruning the portfolio? Can you just give a little color there?

I think it's a blended strategy there. Loan sales -- obviously, you've taken pretty significant discounts. And I think that's one piece of the strategy. I don't want to use that because it uses up a provision significantly. But also, just aggressively working and contacting borrowers and setting forth workout strategies with those people -- I think probably since I've been in this position, we have taken a stronger look at that corporatewide.

So it's a major focus of my daily activities. And I think that's served us well. We've got some great opportunities that have been occurring where we have buyers for certain of our customers' assets and those are without any discounts.

Okay. Given the outflow we saw this quarter in the -- I guess the nonperforming bucket -- I know you had new ones come in. But when we look over the next year, is that the type of -- if you have less inbound credits, I guess -- can you quantify maybe -- was this a large quarter reduction at the $7 million that came out this quarter, were there a couple of larger credits that came out there? Was it just one credit, and maybe just a trend as you look to what you're trying to clean up there, what's possible -- maybe what might be coming out of that over the next 12 to 15 months?

Sure. It's Mike Rechin, Brian. I would offer this. Of the $7 million that came out, roughly 50% of it was through loan sale and 50% of it through our own workout efforts.

As you have come to know us, we haven't used that loan sale channel extensively. And it was a good experience for us, not only for the actual exit, to the extent we took advantage of it for roughly $4 million, but also just to see the process. Our timing of the use of that channel was -- I would call difficult, in that it obviously transpired in the third quarter right at the time when the credit markets were pretty tumultuous, given the disclosure of a lot of what was taking place at the larger banks and in the mortgage sector. So I think there was some behavior on the part of the buyer that reflected itself in lesser pricing than what we would've otherwise seen.

And actually, in some of the workouts that we've executed on our own on assets that we had priced, we saw that we were able to with buyers effect the sale at much higher prices closer to par than what the secondary markets offered.

So we're growing to continue to stay in that channel live. I feel like our own efforts probably will match that.

Okay, and lastly, can you just comment a little bit -- just since we've seen with a lot of our other banks some problems within that construction portfolio, can you just assess the health of your portfolio and just what you guys are seeing?

It's a good question. We're paying a lot of attention to that sector. We've been a busy, over the years, investment real estate bank to include the construction sector. The markets that we do business in are materially slower. We do have a couple of credits in our criticized asset list that we're paying particular attention to. But we're trying to be as proactive with the borrower and our understanding of the market as we can.

On a go-forward basis, we are revising here in the fourth quarter exactly what our construction policy ought to be in light of the changes in the environment.

Okay. And the last one, and I will hang up. Do you have the exact -- I guess can you quantify the amount of nonperforming assets that are construction oriented?

Actually, in the nonperforming reported totals --

It's not significant in our quarter-end non-accrual total, Brian. The names that we pay the most attention to are on our criticized list.

David Dusenbury, Dalton Greiner.

Just a follow-up on that construction development loan question. Can you just help me understand what's in the portfolio in terms of -- maybe give me a percentage breakdown of loans to builders, kind of spec-type building loans, versus loans to individuals or commercial real estate development?

We can. We're going to pull some numbers together for you here in a moment.

Great, okay. And in that, if you could, the land, as well -- raw land.

You know what, David, I'm not sure we're going to be able to get that as timely as this call would allow.

Okay. That would just be helpful for us just to understand -- if you are not big in the builder lending segment -- maybe you can just characterize it for me.

I think of the -- I can speak to this. I can't tell you the specific numbers, but of the top four industries that we serve, the top two are commercial real estate loans -- those that are fully amortizing. This next one would be construction and development, the third would be agricultural. And I think the fourth would be residential. So those are the top four, I guess, categories.

But I think the question earlier, just reflecting on it, and I don't have any specifics right in front of me, but of our troubled assets -- and as Mike said, most of those are criticized if they are in that category for land development. So we've got our problems, but I think we've identified those, and we're working through those. We're still selling lots in these areas, and most of them are still fully accruing.

So I don't have any other information right in front of me, but I can get that information if you need it.

Gentlemen, there are no further question in queue at this time. I would like to turn the floor back over to management for closing comments.

Thanks, LaTonya. We appreciate your continued interest. We hear the flavor of the questions around proactive management of risk in the portfolio. We can provide additional color should you want to call us and get you some more specific numbers on that, but feel like the soundness of our policy and the communication of those out to our bankers in the field is very complete. We look forward to putting together a solid fourth quarter, and talking to you early in the year. Thank you.

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