First Merchants Corp (FRMEP) 2008 Q3 法說會逐字稿

Hello, and welcome to the First Merchants Corporation third quarter 2008 earnings call. All participants will be in a listen-only mode. There will be an opportunity for you to ask questions at the end of today's presentation. (OPERATOR INSTRUCTIONS) During the call, management may make forward-looking statements about the Company's relative business outlook. These forward-looking statements and 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 indication regarding the financial services industry and the economy and future growth of the balance sheet or income statement. (OPERATOR INSTRUCTIONS) Please note, this conference is being recorded.

Now, I would like to turn the conference over to Michael Rechin, CEO. Mr. Rechin, you may begin.

Thank you. Welcome to our earnings conference call for our third fiscal quarter, the nine months ending September 30, 2008. I truly appreciate your interest in our progress. Joining me today are Mark Hardwick, our Chief Financial Officer; Mike Stewart, Chief Banking Officer; Dave Spade, our Chief Credit Officer; and John Martin, Deputy Chief Credit Officer. I'll lead off with our coverage of third quarter results as well as a few comments on the environment, and our First Merchant franchise; Mark Hardwick will follow me with additional commentary on our financial results; and Dave Spade will conclude with details on our portfolio composition and its overall credit condition. We're all available for a question and answer dialogue after our prepared remarks.

As our release states First Merchants Corporation earned $0.32 per share in the quarter versus $0.46 in the third quarter of 2007. Year-to-date, our earnings of $1.13 per share are 8% below the $1.22 we earned through September 30, 2007. Our Company comes through a chaotic year-to-date 2008 period confident in our market position and in our commitment that our capital position and balance sheet bode well for the future.

Our third quarter results contain the credit costs associated with the overall deterioration and higher charge-offs, coupled with a continued build of our loan loss reserve for the current economic recession. The allowance reserve is 27% or $7.5 million greater than the September quarter of last year. While we are mindful of the negative impact of the increased allowance on 2008 earnings, we also recognize that the vast majority of the allowance increase stems from additions to our environmental factors. In fact, the specific reserve portion of the allowance is below the levels reported in any of the earlier quarters of this year.

Our management's vigilance and the processes we utilize for identifying, measuring and managing troubled loans allows that management team the chance to strategize, communicate and act, maximizing outcomes. While the length and depth of the current credit decline is unknown, our approaches and process to do assess risk and plan action are common throughout the Company. Dave Spade will speak in more detail for information of interest regarding our loan portfolio.

I'd like to share a few thoughts outside our credit results. In the third quarter we completed our fifth consecutive quarter of net interest margin growth. Our bankers are proactive with pricing, reflected on both sides of the balance sheet. More specifically, we've displayed the ability to manage deposit costs, consistent with Federal Reserve actions, while growing deposit volumes. Our loan underwriting, now and looking forward, contains the structure and pricing commensurate with the increased risk of our economy. As our balances reflect, as our balance sheet reflects, we're growing our balances selectively and prudently, in my opinion.

Our non-interest income results for the quarter are only ordinary but deserve comment. The quarter's results contain the write-off of $1.5 million, the entirety of our Freddie Mac preferred stock holdings. In addition, our trust company, growing consistently through the past years, have results that were th lowest in six quarters, reflecting the effect of the steep decline in the equity markets and the value of assets under management. I'm encouraged that our service charge income rebounded from earlier quarters and is up 5% year-to-date, year-over-year and 10% in third quarter over third quarter of 2007.

Our expense levels are actively managed and overall are 3.7% year-to-date over those of the prior year. I'd like to point out that within the expense numbers included in other expenses year-to-date our OREO costs and legal costs, $1.4 million higher than the prior year, a further reflection of the costs of the credit cycle to our profitability. Throughout the third quarter, in particular, we prioritized a consistent message to our employees, our customers, and our communities. The message is one of absolute availability of banking service and capability to serve. Our employees' ability to live that message accounts in great part for the strength we maintained in this challenging period. Our direction forward is to bolster our financial and non-financial resources to exploit this unique, challenging yet opportunistic environment.

Before asking Mark to speak to our financials, I wanted to share a comment about our collective excitement for our upcoming acquisition in combination with Lincoln Bank Corp., its employees, and its customers. As the release states, we're on track with all of the regulatory applications associated with the merger. At this point, a detailed integration plan involving employees from all of First Merchants and Lincoln has taken root in preparation for the legal closing and subsequent integration. Mark, could you provide some additional detail on our third quarter?

Yes, thank you, Mike. To everyone on the call today thank you for your interest in First Merchants Corporation. It's been said that the pessimist sees difficulty in every opportunity and the optimist sees opportunity in every difficulty. The times are truly remarkable. For those of us who have chosen to make a career of banking today must be the greatest opportunity of our careers. The challenges are real and those with questionable motives and policies are suffering tremendous losses. Today more than ever, conservative, diversified focused companies like First Merchants are weathering the storm best and should emerge from this difficult time with the greatest opportunity.

Our balance sheet mix is well diversified and conservative in many standards . Our assets totaled $3.864 billion as of September 30, 2008, loans and investments, our primary earning assets totaled $3.5 billion, as investments declined $86 million and loans increased by $208 million. The growth of our loan portfolio reflects a more commercial business orientation, while remaining prudently diversified.

C&I loans increased by $224 million from this time last year. With C&I business loans comes the opportunity for cash management services, 401(k) administration, property and casualty, and healthcare insurance not to mention the personal needs of the business owner and his or her employees. Dave Spade will cover the risk associated with the loan portfolio in just a moment. But I would add that we are not only well diversified by type of risk, but we're also well diversified by borrower. Our top 25 relationships average less than $10 million per relationship, and with a legal lending limit of $52 million, our largest single exposure is 35 -- our largest single commitment is $35 million with $16 million currently outstanding. Our bond portfolio totals $389 million and is well diversified including $205 million in agency backed CMOs and whole loan securities, $139 million in municipal bonds and $13 million of both trust preferred pools and agency bullet securities.

The FAS 115 adjusted market value totals $385 million compared to $389 million of book value reflecting a discounted cash flow value of our trust preferred pools versus the current market value per the SEC and FASB clarifications from September 30, of 2008. Total deposits increased during the past year by 5.6% fueled by $96 million of BDA growth representing 11.6% growth rate and reflective of improved focus by all of our cash management personnel, branch managers, and our commercial bankers.

Total stockholders equity increased by $20 million from September 30, 2007, to September 30, 2008, resulting in an improving tangible capital ratio from 5.56 to 5.92%. The corporations exceeded all three of the Federal Reserve's capital (inaudible) requirements as to qualify as well capitalized as the total risk based capital ratio exceeds the 10% threshold totaling 11.2%. The management team of First Merchants views the Federal Reserve's capital purchase program as constructive and we are in the process of consulting with our Board of Directors on the matter.

Brian Martin who works for Howe Barnes Hoefer & Arnett in Chicago does an outstanding job of working to understand the run rate of First Merchants. His estimate for our Company totaled $0.40 per share this quarter. Our actual results missed that estimate by $0.08, totaling $0.32 per share. Our year-to-date EPS totaled $1.13, down from the prior year of $1.22. A decline of 7.4%. The details of how we landed a $1.13, our mixture of great net interest income growth, offset by prudent and higher than expected levels of provisioning as mentioned by Mike Rechin. I believe that if you look at Brian's great work related to our year to date and quarter to date earnings the shortfall in our performance is very much centered around the responsible and prudent building of our allowance for loan losses. I'll cover the details of the allowance calculation in a moment.

On a positive note, year-to-date net interest income improved 32 basis points or $13 million over last year due to several factors including our correct positioning regarding falling interest rates and the sale of our interest rate closed on August 1, of 2008, that added approximately $275,000 per month to our net interest income. Aggressive loan and deposit pricing activities as well as our strategic changes and our balance sheet mix. Non-interest income absent the write-off of the $1.5 million this quarter related to Freddie Mac preferred stock improved year-to-date by $1.1 million or 3.8%. The growth is primarily driven by service charges on deposits and insurance commission, income and the sale of back to back interest rate swaps for customers looking to lock in long-term rates while keeping our balance sheet variable with floating rates.

Non-interest expense increased by [$2.9] million or 3.7%, as salary and salary and benefit expense increased by $3 million, and expenses related to ORE maintenance and legal fees for the year increased $1.3 million.

Please bear with me for just one moment as I go through some fairly significant details around the allowance for loan losses. In reviewing our allowance for the trailing four quarters ended September 30, 2008, it's important to note that the provision expense totaled $20.4 million. Charge-offs totaled $13 million. The entire $7.4 million or excess provision over charge-offs is in addition to the general historical and environmental section of our AOL calculation. The increase in our reserve is not based on actual recognized or anticipated losses in specific reserves or specific allocations. As specific reserves are the review of discounting cash flows and appraised values of our collateral, we deemed those areas to be sufficient to repay the debt as we deem those areas sufficient to repay the debt, that portion of our allowance actually declined by $924,000.

So again, if you look at our reserve provision expense, $20 million, charge-off, 13, a decline of specific reserves that are resulting from the review of discounted cash flow and appraisals, that would be deemed insufficient to pay the debt on the balance sheet, that section of our allowance calculation declined by $924,000. So all of the increase is a positive movement to recognize the economic environment that we're in, totaling a little over $7.4 million. Prudent management of the AOL in accordance with the OCC guidelines, economic trends and sound banking practices are not specifically identified in anticipated losses in the portfolio was the activity that's reflected in the reserve. At this point, Dave Spade will cover the details around credit quality.

Thank you, Mark. As Mike and Mark have mentioned in their comments we have continued to see challenges in this credit environment with identification of weaknesses in some areas. Although we're not immune to the larger economic issues facing the real estate markets, we are well prepared and positioned to identify and manage our problem assets through our processes, aggressive collection, legal and the marketing of other real estate owned. Allow me to highlight some of the prominent changes to our credit portfolio during the third quarter and discuss steps we have and continue to take to identify and better manage our ongoing portfolio and more specifically, our troubled assets.

As of September 30, 2008, First Merchants Corporation saw non-performing assets plus 90 day delinquencies increase to slightly less than $63 million from $55.3 million in the previous quarter. Those NPAs represented 1.63% of total assets. The top three non-performing relationships which include other real estate owned totaled $5.6 million, $5.4 million, and $5.4 million respectively, and accounted for 26% of the total non-performing assets for the quarter. These three assets were identified in previous quarters and specific action plans have been developed to either move those assets out of the Corporation, or sell the other real estate owned.

The biggest change in non-performing assets was the increase in 90 day delinquencies. This category increased by $4.5 million, due primarily to one commercial loan totaling $1.8 million, that was not renewed until after the end of the quarter. That loan represented a past grade credit on which certain complex documentation issues could not be resolved and the loan could not be extended until the end of the third quarter. Another loan of nearly $1 million to a commercial and industrial customer that had been over 90 days past due has subsequently been paid in full after the end of the quarter. Two other development loans and one healthcare borrower totaling $6.2 million accounted for the remaining material increases to the non-performing loans this quarter. Other real estate declined by $300,000, as lot development sales from a foreclosed property in the Lafayette market has been realized.

Public announcement of a new manufacturing facility in Muncie will ultimately provide for reductions in other real estate owned during the ensuing quarters. First Merchants Corporation is expecting land sales plus the sale of a spec building in a well located special park near interstate 69. That property has been owned by the bank since early this spring. Two large parcels of land plus the building should ultimately allow up to $3.5 million in OREO reductions. Another commercial property in the Indianapolis market will be sold yet this month, with another paydown of $800,000 in other real estate owned. The Corporation continues to aggressively market these real estate assets. A high level of interest in lot development, real estate owned by FMC in Indianapolis may bode well for further reductions.

Annualized net charge-offs for the three months ending September 30, 2008, represented of 0.49% of total loans, compared to 0.39% one year earlier. For the nine months ending September 30, 2008, the annualized net charge-offs were 0.5% compared to 0.24% in the same period in 2007. This performance category represents the continuing challenges faced by First Merchants Corporation during this economic cycle. Total residential mortgage loans at FMC showed a delinquency rate of 2.39%, compared to 2.31% at the end of the last quarter.

During the same period last year, the 30 day and over residential delinquencies were reported at 2.12%. The volume of residential mortgages outstanding has fallen $39 million during the last 12 months, so the delinquency percentage has shown little volatility during the last year, due to aggressive collection activities. Total commercial delinquencies were reported at 1.6% of outstandings, in that category, compared to 1.06% at the end of the second quarter. As mentioned earlier in my remarks, two large 90 day accounts were either paid or renewed since the start of the fourth quarter. That would represent 28 basis point reduction in commercial delinquencies had those two events taken place prior to the end of the quarter.

The seasonally adjusted delinquencies for residential mortgages provided by all banks as presented in the latest release by the Federal Reserve stood at 4.33% while commercial loan delinquencies during the same time frame represented 1.67% of total C&I loans outstanding by all banks. FMC continues to perform favorably in the controlled delinquencies by comparison to the composite totals of all banks in the United States. The delinquency levels of total loans and leases nationwide were reported at 3.31% compared to FMC at 1.71%.

Construction and land development loans were $167 million at quarter end, as compared to $182 million for the period ending June 30, 2008. Those loans represented approximately 47% of Tier 1 capital, plus the allowance for loan and lease losses, compared to approximately 52% at the end of the second quarter. Construction, land and development loans represented 5.4% of total loans as compared to 6% of total loans on June 30, 2008. We continue to closely monitor this portfolio for existing projects as well as being selective with any new credit exposure to that industry. Multi-family loans were $108 million or approximately 30% of Tier 1 capital plus the allowance and 3.5% of total outstanding loans.

Finally, investment commercial real estate with balances of $387 million were approximately 110% of Tier 1 capital, and 12.7% of total loans at FMC. Overall, total commercial real estate including land development, non-owner occupied property, and multi-family loans represented 21.7% of total loans at First Merchants Corporation. I'm going to turn it back over to Mike for comments.

Thanks, Dave. And before you open it up for questions, I thought I would just add a few summarizing and maybe personalizing comments as follows. Today's call might have been heavy in metrics, intentionally, because we think the environment deserves such and I hope that you found them illustrative of the effort we're putting behind maintaining adequate credit quality and very consistent with the balance sheet and income statement that's been provided. The personalizing, I guess would be this. We continue as a Company to enjoy high market shares in stable communities in the Midwest. Punctuated with the higher growth markets of Columbus, Ohio and Indianapolis. I'll circle back to Lincoln in a moment. We have market momentum in virtually every place we conduct business. It's allowed us the wherewithal and stability to grow in a climate that I would readily admit is different and tougher than we might have chosen. But we don't have that choice.

The last thing I would offer is that we don't have to stretch and won't stretch. The credit extensions we make are in our communities and in the states in which we conduct business. So if you you ask where is our risk, let me be more clear. It's not in the numbers you heard. It's in consumers, across our franchise, it's not in credit cards, it's not to any great degree in home equity lending. It's in lending to people directly for the vast majority of our consumer lending and assets that are productive for our customers. Our portfolio and as such then our risk is in small business. As diverse as niches like healthcare and dentistry and veterinary medicine. It includes agra business. Customers that go to work every day. And it includes the middle market which is an increasing piece of our business in C&I and it includes the real estate assets for all of those sectors.

So that's First Merchants, and at this point, I guess I would just use that backdrop as an explanation for our interest in Lincoln Bancorp which shares many of the same niches, the same profile in terms of a metro mix as they penetrate Indianapolis coupled with rural communities that they serve awfully well, and a management team equally focused. So that's our direction for the balance of this year and into 2009. At this point, we are available for questions.

Thank you. (OPERATOR INSTRUCTIONS) Our first question will come from Joe Stieven from Stieven Capital. Please go ahead.

Hey Mike, hey, Mark, how are you.

Good afternoon, Joe. Well, thank you.

Couple things. Could you go back over what you talked about on the MPA side. You said you had a big piece of foreclosed real estate that was going to be coming out due to I think somebody moving in town. Go over that a little bit. Then you also talked also talked about how much you said you had for sale or that was going to close very soon. That's question number one. Then question number two is, if you really go through your operating earnings, if you add back the Freddie, Fannie and maybe just part of the reserve build, it looks like the quarter was a lot closer to $0.40 on a pretty clean basis and just sort of a comment on that? So that's it guys, thanks.

I'll speak -- this is Dave Spade. I'll speak to the question with regard to the real estate. We have a development park near I-69 west of Muncie. We've owned that since spring. We had to go through a foreclosure process to wipe out any of the liens against the property. So we've owned it since April and March. We have a buyer for the building. We're very glad to say. And an additional 20 acres. We have another 20 acres that we anticipate receiving an offer on with good certainty through the chamber's message. So we understand that that will take 40 acres plus our building. We'll have approximately 140 acres left in that park and a lot of that acreage is a lot more expensive.

And what will that result in a reduction in your foreclosed, assuming that goes through as you're saying?

Well, we'll see at least a $3.5 million reduction in other real estate owned. Was that your question?

Yes, it was. And then what about you said you had some sales pending right up in India, I believe.

We have some level of interest by some very serious and qualified purchasers on a couple of development lots, or development projects, rather, in the Indianapolis market so we're confident that some of that will come to fruition.

We have an OREO sale this Friday, don't we?

We have an OREO sale that's going to be upcoming on Friday.

Just like $1 million.

Less than $1 million, I did speak to that, thank you, Mike, for reminding me. We do have an other real estate owned, it's a commercial warehouse and we're going to have a full recovery on what we have on book balance today, approximately $800,000.

Okay.

Joe, on the question that you had around maybe more of an operating and run rate for our Company, I referenced Brian's work around our earnings estimates and he had expected for us to have provisions in the $4.4 million range and we provided 7. Looking at a couple of different scenarios, on the -- probably the higher end would be the estimate Brian had, which would add about $0.09 a share and then the Freddie Mac preferred was about $0.05. So that's $0.16 -- or $0.14 from $0.32 to $0.46. On a more conservative posture, a more conservative end, if we were to just back $1.5 million out of the reserve next quarter, not be quite as aggressive and have the $1.5 million, the elimination of that Freddie Mac on a go forward basis, that would add $0.10 to the operating income, which would be $0.42. So, obviously in this environment, we're watching our credit very closely. We're not giving guidance on earnings. Those are reasonable, I think ways to look at this quarter as to what a more normalized run rate might be.

Okay. Thanks, guys.

Thank you, Joe.

Our next question will come from Brian Martin from Howe Barnes, please go ahead.

Hi, guys.

Good afternoon, Brian.

Say, just a couple questions. Maybe for Dave. On the credit side you talked about the increase in non performings this quarter. You talked about a couple credits that went away. The increases, I think, Dave, you said were three credits. I was just curious what those were size wise, if you could give a little color on that increase, of those three credits.

Sure.

Kind of maybe what markets, the size of the credit and whatnot?

Yes. These are all in the Indianapolis or Lafayette markets. One of them is a medical practice. We think there's going to be a resolution to it but we need to bring the people to the table and they've gone over 90 days. We've put that in the non accrual category, it's about $1.2 million. We have another that's about $2.6 million in the Lafayette market, that's a development loan, residential land development loan. And another development loan of about $1.8 million, that's in the Indianapolis market.

Okay. And then --

Development loans.

--C&D portfolio it's down, 5.5% of the total outstanding. What percent of those at this point are non-performing?

Of the C&I loans?

No, of the construction development loans?

Of the construction.

I thought you said they were about $167 million or somewhere around 5% of the whole portfolio.

Let's see. About 5.9%, almost 6.

Okay. So 6% of those are non -- 6% of the 167 are non-performing?

Yes.

All right. Just I guess away from the credit side for a minute, just the -- can you comment a little bit just on the loan pipeline and kind of what you guys are seeing and maybe just give a little color where your Indianapolis footings are right now, before you close a transaction of Lincoln and maybe just kind of some expectations for that market, as you go forward and fold them in.

Sure, Brian, it's Mike. The -- you talk about the environment itself. Loan demand is probably as strong as I can remember it. And it clearly then, all of us knowing the general economic conditions, isn't reflective necessarily of economic vitality, but somewhat I think of the fact that all financial institutions have really modified their appetite. Some of the larger super regionals seemingly, not willing to lend at all, although that would just be my opinion. It does manifest itself in our bankers seeing more opportunities. That won't reflect itself, Mike Stewart is here with me. That won't reflect itself in our earning asset growth meeting that demand level, because of our own appetite to refine our underwriting and to add continued balance to the portfolio.

Okay.

Mike Stewart, I thought I would just throw in there. The Indianapolis footings today are about $260 million, speaking to the backlog that you referenced and to augment what Mike said, it is as robust of an environment now or our bankers looking at opportunity. We have the luxury to be opportunistic around those with better pricing and better structure around all of the markets, but in particular, the larger metropolitan areas of Indianapolis, Columbus and where we reach near Fort Wayne and also near Lafayette.

Okay.

Your last -- it's Mike again, Brian. I think you also at the tail end of your question asked for what plans we might have for Lincoln and the philosophical approach to the marketplace with between our leadership and theirs is several months old at this point as we've come to know each other and look upon the opportunities with a similar set of eyes and so that would have, in my opinion a continued execution around what you've seen First Merchants do for the last year, which is dramatically reduce any indirect lending, if not eliminate it, and to be scrutinizing what mortgages go on our balance sheet and try and maximize liquidity in the light of what we think of as opportunity. Lincoln has some really enviable depository market positions in communities that we find highly attractive and we're learning more about it as we speak. So I think our plan will be to incorporate the historical effort we've had with great success, up in the Madison county market through First Merchants Bank of Central Indiana, coupled with Lincoln and our current Indianapolis business.

Okay. How about just jumping to the expenses for a minute, maybe Mark can give a little color on just the FDIC expense this quarter and kind of what to expect as we look to '09, with what type of increase you guys are going to have.

The annualized run rate of our FDIC cost is about $700,000 a year. We don't have that number exactly from all the research we've done, we've tried down the changes that are coming and understand where the environment is headed. But our estimate at this point is that the number will essentially double next year over this year. So another $700,000 of FDIC insurance costs in '09.

Okay. And how about just on the margin with the 50 basis point drop here as far as what that means or how you guys are looking at the margin going forward. I know you talked about getting some better pricing both in the loan and deposit side. Two questions, 50 basis point impact on the margin and then just what pushback if any are you guys getting from your loan and deposit customers as you change those, try to modify those rates?

From a margin perspective, we've modeled our net interest income in a down 100 environment. Obviously, the lower rates go, the more compression we start to see because we run out of room on the DDA money market side or the money market and advantaged type of checking area. Our CD portfolio remains relatively short and we'll continue to reprice. We have about $650 million of loans tied to prime. And once we hit these levels, the below 2, especially if we were to move below 1, we start to see some margin compression, but based on our ability to reprice credits in a more competitive environment, our ability to renew our CD portfolio and our borrowings in a relatively short time frame, the margin question for us is one that we feel it's going to remain really stable. I mean, for us to see a couple basis point decline is about all I would expect from this last 50 basis point move.

Okay. And your fixed versus floating rate loans right now, you said it was 650 is floating?

Well, we have 650 that are tied to prime daily. We have about $140 million that are tied to LIBOR that float daily.

Okay.

We have base rate loans that are in about the $150 million that reprice off of our base rate. Our set change and we were pretty conservative in the rate movement down on this last 50 basis point move, feeling like our base rate was already an attractive rate. So of the balance sheet, very short portfolio, but the variable daily are really the ones I just mentioned.

Okay. And then the -- I guess last thing. You mentioned this, maybe I didn't hear it right, Mark, just the pool trust preferreds you guys have as far as writing those down or looking at those valuation-wise, sounds like the cash flow is supported at this point, and that's unlikely. Is that kind of what you were talking about earlier or did I miss that?

Given the FASB and the SEC's improved guidance around 157, the discussion around distressed asset sales and mark-to-market adjustments, we've performed a discounting cash flow analysis on our trust preferred pool. We're in the most protected tranche in those trust preferred pools, accepting a lesser yield for that protection on the asset side and based on the current defaults in those pools, the current deferrals in the pools and even what we felt like were fairly conservative estimates of continued or new defaults and deferrals, the market values, the discounted cash flow value came in much stronger than the fair market value. I think it's an interesting time the way fair market value has had a role and an impact in the activities of the economic climate and I was glad to see that change made or the announcement that came out, guidance from the SEC and FASB and we've evaluated those trust preferred pools and feel great about the continued cash flow of those securities.

Okay. And last thing, and I'll hop, is the expenses associated with the integration of Lincoln, can you talk about any one-time charges or just kind of how that's going to roll through or?

Yes. We do have some integration expenses that we've built into the plan somewhere, it's about $260,000 to complete the integration which is scheduled right now -- well, scheduled and we've already kicked off the plan to happen early April. So we've got -- those are deconversion type costs directly to Fidelity. We'll have a few smaller deconversion expenses for online bank or I'm sorry conversion expenses for things like online banking, et cetera. And then we have some legal costs, obviously, on our end relative to the work that's been done for our S4 registration statement and our DFI and Fed applications, of the 100,000, $150,000 range. So the legal costs will likely be expensed this year, with the remaining amount being expensed next year for all the conversion expense.

Everything -- as we go through the due diligence or not due diligence but the preparation for closing of Lincoln, we're monitoring very closely all contracts that need to be cancelled on their side, making sure their deconversion expenses are fully accrued prior to close, that we've evaluated the loan portfolio in detail. We've had our loan review team there for the last two weeks, working very closely with Lincoln's management, ensuring adequate discounted cash flow analysis and appraised values your for every credit to ensure that when we close the acquisition, bring Lincoln on to First Merchants Corporation, that the balance sheet is positioned as well as possible to perform in the future for our organization. So a lot of work being done but as far as the expenses on our side, it's primarily limited to our people's time. The conversion expense at Fidelity and then additional conversion cost of a more negligible amount from our other core vendors and the legal expenses.

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

Thank you, Brian.

Our next question will come from Brian Hagler from Kennedy Capital. Please go ahead.

Hey, good afternoon, guys.

Good afternoon, Brian.

I guess in your earlier discussion I missed what the total amount of the trust preferred pools was?

It's about -- it's right at $13 million.

Okay. And how much have those been marked down year-to-date or have they been?

We have just a FAS 115 adjustment that's, what, 3%. Yes, relatively low, because of the more protected tranche that we're in.

Right. Okay. Great. And then I guess Mike, sounds like you guys are positively inclined toward the government capital program. You also mentioned that you're going to be disciplined growing the balance sheet, despite having pretty good loan demand. So can you just kind of talk about maybe what bank acquisition opportunities there may be or branch acquisition opportunities there could be, in which markets you'd be focused on more than others?

Sure. I'll be upfront and tell you that outside of Lincoln, we have nothing else that's taking a lot of our time at this point and as we look to take advantage of what Lincoln brings to us in the greater Indianapolis market, a lot of our thoughts beyond its integration in the April time period relate around where do we take the branch network from there which could manifest itself by way of selected acquisitions. It's probably equally likely, if not more so that it would be organic in the communities that we think bridge our current footprint and that of Lincoln's. That's kind of where we are. I hope that speaks to your question.

And can you just maybe talk about, will First Merchants and Lincoln I'm assuming be looked at as separate entities because the deal's not closing until after the November 14, cutoff as far as eligibility goes?

In terms of the capital program.

Yes.

That's our understanding. With the details roughly a week old or 10 days old, we're still doing our own independent investigation of them, coupled with some of our advisors, law firms and such. But yes, as it stands, to your point, we would view that an application process would be independent and the amount of our interest in it is also still ongoing concern, but as Mark offered in his thoughts, the most significant known component to the program appear to be lucrative to a Company like ours that's growing and in it for the long haul, because more capital, especially at the price included in this program, seems to be very lucrative.

All right. Great. Appreciate your comments.

Thanks for the call.

This does conclude today's question-and-answer session. I would like to turn the conference over to Mr. Rechin for any closing remarks.

Thanks. These will be brief. I appreciate all of the interest and would repeat that fact. It's a longer call than, but the quality of the questions is appreciated by our team. I would end by saying that the results we've discussed today, at least for the third quarter, are neither outstanding as you read them, nor satisfying to our management team. They are reflective, though, of a team of folks absolutely committed to balancing decisions for the short and long-term and look forward to talking to you again about our year-end results at the end of next quarter so thank you very much.

This does conclude today's conference call. Thank you for attending. You may disconnect now.