First Merchants Corp (FRMEP) 2009 Q1 法說會逐字稿

Hello and welcome to the First Merchants Corporation first quarter 2009 earnings call. All participants will be in 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 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.

(Operator Instructions). Please note this conference is being recorded.

Now I'd like to turn the conference over to Mike Rechin. Mr. Rechin, please go ahead.

Thank you, Andrea. Welcome to our conference call for the three months ended March 31st, 2009. I appreciate your interest in our progress and I hope you find the call informative. Joining me today are Mark Hardwick, our Chief Financial Officer; Mike Stewart, our Chief Banking Officer; Dave Spade, Chief Credit Officer; and John Martin, Deputy Chief Credit Officer. I will summarize our first quarter results as well as other significant events since the end of 2008. I'll begin with our financials.

In the first quarter, First Merchants Corporation earned net income of $4.1 million versus $8.1 million earned in the first quarter of 2008. Our earnings per share available to common shareholders were $0.17 versus $0.45 earned last year, reflecting both lower earnings and the effect that dividends paid on our preferred stock. Given the year end acquisition of Lincoln Bank Corp., our year-over-year comparisons deserve the additional discussion contained in our release and what you'll hear from our other senior managers thus afternoon.

On our last call, February 5th, I summarized our key 2009 priorities. Those have not changed and are as follows -- capital and liquidity management, asset quality, net interest margin management, expense management, and the success of the Lincoln acquisition. Beyond our financial detail, our goal is to update our progress on these objectives as we approach mid-year.

Our release covers several in my mind transformational actions since year end. In February, we were approved for $116 million participation in the capital purchase program and we closed that participation on February the 20th. On March 31st we closed on $79 million of temporary liquidity guarantee program funding as part of a larger pool of funding. More recently, the weekend of April 16th and 17th, we fully integrated Lincoln's product offerings, core processing, and technology to our systems just over 100 days from our legal closing. Our integration went smoothly through the coordinated leadership from technology, project management, and all our line of business managers. The customer change events and notification were part of an overarching branding and marketing effort that continues and includes our website and Internet banking channels. At this point we're delivering customer responses to the questions that arise from the welcoming of our newest First Merchants customers.

Our release speaks to the expense efficiencies that come from our combined companies. We'll see immediate reductions in our operating expenses, having made the personnel determinations earlier in the year. The severance expenses are behind us and the reduced payroll is included in the $5.5 million of projected savings. Beyond the Lincoln combination, we initiated personnel reductions in all of our operating units during the first quarter. The reductions are appropriate for the current operating environment and the severances were expensed in the first quarter, totaling nearly $400,000. In addition, we made other prudent compensation adjustments, including the elimination of merit salary increases to all the participants, roughly 80, in our senior management incentive plan. At this point, I'm going to ask Mark to discuss our financial results in greater detail.

Good afternoon. As Mike detailed, the chronology of the last 120 days are reflective on the amount of hours our teams within FMC have worked to produce the results before you today. To everyone on the call, thank you for your interest in First Merchants Corporation, and to our employees, your attitude of perseverance and professionalism will allow for continued improvement in our results.

First Merchants Corporation's first quarter 2009 net income and earnings per share available for distribution to common shareholders totaled $3.5 million and $0.17 respectively. The results are down from the first quarter 2008 numbers totaling $8.1 million and $0.45 per share. Total assets reached a record $4.9 billion at quarter end, an increase of $1.1 billion from March 31, 2008, totaling $3.8 billion. Of the $1.1 billion increase, the completion of the merger with Lincoln accounted for $876 million in assets.

Loans and investments, the corporation's primary earning asset, totaled $4.1 billion, an increase of $742 million over the prior year. Loans accounted for $722 million of the increase as investment securities increased by $20 million. Of the $742 million increase, the acquired assets of Lincoln accounted for $637 million in loans and $122 million in investments. The corporation's allowance for loan loss as a percent of total loans increased from 0.99% as of March 31, 2008 to 1.60% in 2009, a $29.4 million increase.

Provision expense exceeded chargeoffs by $6.9 million during the quarter, and the acquired allowance of Lincoln Bank totaled $10.7 million. The increase in the allowance for loan loss total is comprised of specific impairment reserves or FAS 114 allocations totaling $14.6 million and $43.9 million of FAS 5 pools. Nonperforming loans totaled $109 million and our Chief Credit Officer, Dave Spade, will provide the color regarding the loan portfolio.

The corporation's total deposits increased during the year by $872 million as Lincoln Bank accounted for $655 million of the increase. Total borrowings increased by $22 million, including $137 million addition from Lincoln Bank and the addition of $79 million of temporary liquidity guarantee program for the TLGP funds announced by First Merchant on April 1, 2009. Our loan to deposit ratio is below 100% for the first time since 2003, and for the second quarter in a row we have maintained a Fed funds sold position. At quarter end, the Fed funds sold totaled $89 million in Fed funds, and interest bearing time deposits totaled $158 million. It's true that investors are giving much greater credence to capital and liquidity than in the past and we have made strides to add strength to both categories. As of March 31, 2009 the corporation's tangible common equity ratio totaled 4.88%l our Tier 1 leverage ratio totaled 9.17%; our Tier 1 risk based capital ratio, 10.47%; and our total risk based capital ratio totaled 12.97%.

The improvement in the corporation's regulatory capital ratios of more than 20% from year end 2008 are directly attributable to the addition of $116 million of preferred stock issued by the US Department of Treasury through the capital purchase program. We believe the addition of capital in this economic cycle was prudent and that Treasury's offer was the least expensive alternative for First Merchants Corporation's shareholders. Any other capital alternative would have been more dilutive to our shareholders and imprudent.

Net interest margin declined by 6 basis points from 3.74% in 2008 to 3.68% in 2009. However, average earning assets increased by $901 million. As a result, net interest income improved by $7.7 million first quarter of 2009 over the first quarter of 2008. Management expects margin to improve by 9 or 10 basis points during the remaining quarters of the year as the $160 million of CCP funding and $79 million of TLGP funding are deployed into higher yielding assets on the balance sheet.

Provision expense totaled $12.9 million during the quarter, an increase of $9.1 million over the first quarter of 2008. The increase in provision expense exceeded the expansion in our net interest income by $1.4 million.

Total noninterest income increased by $3.9 million over last year. Of the increase, $2.3 million is the result of selling short-term mortgage backed investment securities at a gain. It is management's opinion that mortgage rates are unusually low due to high demand for these securities by the Treasury Department. Purchases of longer term [geo] municipals are taking place in the second quarter as management adds some duration and yield to the bond portfolio. We are pleased with the quality of our bond portfolio overall and we continue to monitor the only blemish, totaling $13 million in [pretzel] securities for OTTI impairment.

As of the end of the first quarter, we did have a $500,000 write-down on one additional security that is netted against the gain on sale of securities for a total, a net total of $2.3 million. Several additional bright spots include the increase of $787,000 in gains from the sale of mortgage originations during the quarter, the increase in electronic card fees from the roll-out of our debit rewards program of $399,000, and an increase of insurance commissions of $390,000.

Total non-interest expense for the quarter increased $8.4 million. Salary and benefits increased $3.9 million, including $2.9 million attributable to Lincoln, $622,000 attributable to health insurance claims, and another $398,000 in severance payments as the corporation continues to gain efficiencies in the legacy organization. Outside data processing costs included $655,000 to run Lincoln Bank's separate operating platform prior to the integration, and $397,000 of conversion expense or integration expense. First Merchants full-time equivalent employees as of 12/31/08 totaled 1,367, and post integration, total FTEs within our organization totaled 1,238. Again, we're down from 1,367 to 1,238. The synergies derived from the integration were completed on April 20, 2009, and will produce reduced overhead costs in the areas of salary, benefit, facilities, processing, and technology, totaling a minimum of $5.5 million for the remaining three quarters.

Dave will now cover the details of our loan portfolio and NPLs.

Thank you, Mark. First Merchants Corporation has continued to see challenges presented by the deteriorating economic environment at state and local levels. These weaknesses continue to manifest themselves in higher levels of nonperforming assets and loan delinquencies in some areas of the company. Our credit departments, special asset officers, and local bankers continue to manage through problem loan identification, aggressive collections, legal action, and marketing of other real estate owned. I will discuss trends and changes to our loan portfolios during the first quarter. I will also highlight how we plan to continue managing our risk assets as the economic issues continue.

As of March 31st, 2009, First Merchants Corporation saw the nonperforming assets plus 90 day delinquencies increase from $112 million to $138 million for the first quarter. Total nonperforming assets plus 90 day past due accounts represented 2.83% of actual assets and 3.54% of total loans and other real estate owned at the end of the first quarter. The top five nonperforming relationships, including other real estate owned, represent 19.6% of the total nonperforming assets at March 31st, 2009. All of these five assets were identified during previous quarters, and specific action plans have been developed to either move the assets out of the bank or to sell the other real estate owned. On a consolidated basis, the 90 day and over past due loans increased from 16 basis points of total loans during the fourth quarter to 21 basis points of total loans on March 31st, 2009. Compared to the total at the end of the fourth quarter 2008, the overall total 90 day and over past due category increased by $1.8 million to $7.7 million total.

Actual first quarter charge-offs to total loans or FMC were 16 basis points for the first quarter compared to 52 basis points for the full year ending December 31st, 2008. Losses were recognized across all loan categories including commercial and industrial loans, commercial real estate, and the retail lending areas. For the first quarter, net charge-offs at FMC were recorded at $6 million, compared to net chargeoffs experienced during the first quarter of the previous year of $3 million.

Further breakout of those losses include $253,000 in net write-downs of construction and land development loans, while all other commercial real estate losses were $418,000. The commercial and industrial loan losses were reported at $724,000. Net retail charge-offs at the end of the quarter as identified by call codes were broken down by net consumer charge-offs of $639,000. Retail and residential mortgage loan losses represented 74% of net charge-offs during the first quarter. These performance numbers are indicative of the challenges faced by First Merchants Corporation during this current economic cycle.

Residential loan delinquencies that are 30 days or more past due and still accruing interest as well as those in non-accrual status for closed end one to four family, closed end one to four family with junior liens, and revolving home equity lines at the end of the first quarter were reported at 5.07% compared to 3.95% at year end 2008. Fourth quarter information provided in the latest statistical release provided by the Federal Reserve showed that delinquencies for residential mortgages provided by all banks in the United States stood at 6.92% during the fourth quarter 2008. This number is significantly higher than one year ago when the Federal Reserve bank reported delinquencies for residential mortgage loans at 3.74% nationally.

Total First Merchants Corporation commercial real estate delinquencies plus non accrual commercial real estate loans broken out by call code were reported at 4.87% on March 31st, 2009. The $45.8 million in past due commercial real estate loans over 30 days and still accruing interest plus non-accruals compares to the Federal Reserve bank information that showed commercial real estate delinquencies for all banks at 5.63%. As of March 31st, 2009, all FMC affiliates' commercial and industrial delinquencies were reported at $31.8 million or 3.1% of total commercial loans outstanding.

Commercial construction and land development loans at FMC were $208 million at the end of March, compared to $252 million at the end of the fourth quarter 2008. Decreases in this loan category came from payoffs, a slight increase in other real estate owned, or write-offs. Construction and land development loans represent 43% of total FMC capital. Total construction and land development loans represented 5.7% of total loans in the company, compared to 6.8% of total loans at the end of the fourth quarter 2008. We continue to closely monitor this portfolio for existing projects as well as being very selective with additional exposure to the industry. All banks in the corporation show slow land development absorption with 32% of the land development portfolio now in a non-accrual status.

Multi-family loans were reported at $128.5 million on March 31st, 2009, representing 26.5% of Tier 1 capital plus the allowance and 3.5% of total loans. Investment commercial real estate that is non-owner occupied had total balances of $531.4 million or 109.7% of Tier 1 capital plus the allowance. Overall, total commercial real estate including construction and land development, non-owner occupied, and multi-family represent $868.1 million or 23.7% of total loans at FMC.

The consumer monitoring, collection, and charge-off process has continued to improve at each of the banks. Specifically, more standardized asset disposition collection and charge-off processes have helped to reduce the time that repossession and other assets are held prior to sale. As we continue to experience a rise in our non-performing portfolio, we have augmented the special assets team through the addition of two experienced workout bankers. The expanded special assets team meets frequently and works with the borrowers, experiencing the challenges, and where necessary, establishing near term plans to move those assets out of the bank.

The headwinds in our market provide challenges, punctuated by high unemployment. In Indiana, the unemployment is on the higher end of the scale compared to national averages. Several of our mature markets exceed the high state unemployment levels. As you recall in my comments regarding charge-offs, for the quarter, FMC retail and one to four family loans represent 74% of those totals. It is telling to me that our retail customers remain stressed with high debt levels, lower income, and less disposable income as we all navigate through this recession. I'll turn it over to Mike Stewart, our Chief Banking Officer, for comments.

Thanks, Dave. So beyond the credit cycle, the capital purchase program, and the Lincoln Bank integration are our core banking channels of mortgage, retail, and commercial. These business lines are performing well within the respective markets they serve and are benefiting from several local and national trends.

In particular, our mortgage business continues to benefit from the low interest rate environment and the leadership change we implemented at the end of 2008. During the quarter, this group originated over 525 loans totaling nearly $87 million in volume. That represents an increased unit and dollar volume of over 150% from 2008 and up over 50% adjusted for the Lincoln volume. This group's sole focus is on conventional and FHA financing within our footprint and within our originate and sell business model. With the addition of the Lincoln volume, we have reduced our processing cost per loan over 25% while keeping an average closing time of less than 37 days from application.

Our retail banking channel continues to benefit from our local reputation and brand within the communities we serve. Globally, we continue to attract and retain our core retail banking customers as measured by net new accounts, households, and end deposit balances. Our run rate for new account growth is near 1% for the first quarter. While we are not a market leader in interest rates for timed deposits and other savings type accounts, we have increased our core deposit balances by nearly 3%. In the fourth quarter of last year, we rolled out our debit rewards program called the Gold Standards. This has been a successful product launch to date as our actual fee income and net profit margins are running in excess of 15% of our original plan.

Our commercial bankers remain diligent and active in our markets. While our pipeline for new loans have flattened to around $40 million from a peak of over $100 million early last year, our bankers continue to evaluate the same level of loan request as in prior years and prior quarters. We have remained focused on quality loan structures and pricing. In the first quarter, we added over 30 new commercial relationships with loan commitments of roughly $30 million, we extended incremental loans to existing clients of roughly $60 million, and attracted over $40 million of new deposit accounts from both new and existing commercial clients.

The new name and commitment volume is essentially half of where we were the same time in 2008, but we with keeping a similar pace for deposit account growth. Through the second half of 2008, we recommitted ourselves to building deposits and relationships via cross-sell efforts with all of our product partners. Our information technology group assisted in a new tracking tool for our commercial bankers, and we have seen our average number of accounts purchased by our client base increase from 2.5 to over 3 since the end of the year.

Last, I would like to provide an update on our progress in combining the existing Indianapolis offices and personnel with those of Lincoln into the First Merchants Bank of Central Indiana Charter. As you heard earlier, the data integration and system conversion occurred over the weekend of April 17. The change was managed extremely well and customer issues have been minimal. Our banking center managers have done a wonderful job of learning our systems and offering excellent customer service for the past ten days operating under the First Merchants name. In addition, our call center, technology, and operations associates have also done an excellent job of facilitating the transition and supporting our customer and employee needs. Going forward, the First Merchants of central Indiana team will continue to build the culture and process to assure we capture the growth opportunity this new geography offers from a retail, commercial mortgage, trust, and insurance point of view. Mike, I'll turn it back to you.

Thank you, Mike Stewart. I thought I would make -- I want to get to questions here quickly. I thought I would make a few summarizing type of comments.

Mark Hardwick alluded earlier to the overshadowing that has taken place in our results from our credit statistics souring and the costs associated with that. It's true, it's hard to get around it. But the progress we've made on a whole bunch of fronts, I hope we gave you some flavor for today. We are making some substantial progress on very real items that produce earnings that we'll be able to see, even with the credit costs that appear to be steep.

I'm pleased that our construction and land development portfolio included in the long list of statistics that Dave Spade went through is roughly 20% decrease quarter-over-quarter in that portfolio. For a banking company that has no credit card portfolio, a limited home equity portfolio, and a really stringently utilized originate and sell first mortgage business, we are still finding ways to get hurt by consumer weakness, as Dave's numbers provided. So that's frustrating, but it's real. The unemployment scenario that Dave Spade summarized is better or worse in any one of our markets, but as far west as Lafayette to as far east as Columbus, Ohio, an area under stress. And the automotive story that plays out in the paper every day, while we are clearly not an OEM credit provider to any magnitude and a very limited Tier 1 provider, we have a bunch of middle market companies that are Tier 2 providers and we have a bunch of folks in our communities that are employees for OEMs, perhaps for Tier 1s as well as Tier 2s. So the sting of that is probably felt as much in our consumer lending as it is in our small business and middle market lending.

Speaking for a moment longer on the credit deterioration. Really kind of two waves. If you look at what is now a several quarter long increase in several of the categories, I really feel like it breaks down into two waves, and I guess we're hopeful that there's not a third. The first one would have been at 12/31 of 2008 when you add in the loan portfolio impact of Lincoln. It was a company that had a larger than our share historically of real estate and residential real estate. And so that had a spike in it that would have been reflected at 12/31 of 2008, and the deterioration of their portfolio quarter-over-quarter right up through that was somewhat modest. It was about 15%, but only about $5 million for that particular unit. That will be a little bit harder to track going forward because of the combination of Lincoln into FMBCI.

So that would be the first wave, and the second one would be the receipt on our part of the financial statements of our commercial borrowers for the fourth quarter of 2008. And as those came in, I think we all knew that the consumer stopped spending money in the fall. It had a trickle down not only to those folks directly, but to our small business portfolio, and so those statements came with surprises perhaps in a magnitude larger than we thought. But we graded them rigidly and consistently, so I think we have an honest and bright light on the portfolio that we have, which as honest and directed in our efforts towards it doesn't preclude it from taking a little bit longer ride. But I'm very pleased with the resources that Dave Spade and John Martin have put together to police our portfolio and to be as proactive as we possibly can.

Mark touched real quickly -- we reference one of our priorities as being asset quality. We talked extensively about loan quality and Mark made a few remarks around the investment portfolio and its quality. And we've made big headway there, which is why it was probably absent in a lot of remarks today. You may recall from the last call we made some significant portfolio adjustments in the BOLI portfolio that hurt us a little bit last year, did not hurt us at all in the first quarter. And the balance of the bond portfolio has been really actively managed both from our existing team and some of the management that joined us from the Lincoln business. So I feel like we're in good shape there.

Lastly on the revenue front, we haven't forgotten about it, which is why I was so happy to have Mike Stewart highlighting what he's spending almost all of his time on beyond the integration of our greater Indianapolis business, but across all of our banking companies, making sure we're getting the product and revenue opportunities even in this environment. And on a non-credit basis, I'm excited that our trust business and our insurance company, which are services that Lincoln never offered to a really nice marketplace, is something that we're working on knowledge and training on now. I don't expect to see traction in the revenue out of those businesses at Lincoln until after the first half of the year has concluded, but I do see revenue lift in the third and fourth quarters out of that customer base after we get their primary sales force up to speed and some of the familiarity with our tools to a new level.

So that's a lot of attention on your part. I'm going to stop at this point and ask Andrea if she has any questions for us.

Thank you. (Operator Instructions). Please hold while we poll for questions. We have a question from Joe Stieven of Stieven Capital Advisors.

Good afternoon, this is Steve Covington, actually. I know, Mark, you touched on this a little bit and I apologize, I missed part of the call. But you touched on your expectation for some margin improvement as you deploy proceeds and liquidity on your balance sheet. But do you have any idea on the level you could see the margins shake out at over the next couple of quarters? What's the core run rate do you think for the margin for the business?

I stated -- Steve, I appreciate you being on the call. I stated that I thought we would improve margin by 9 to 10 basis points as we move through the remainder of the year. And it's really -- the margin was pretty stable quarter-over-quarter, with the two primary differences being additions to non-accrual and the additions of liquidity through the TLGP and the CPP additional funding. And we really didn't have the opportunity to deploy those assets the way we would like to early after receipt, because we were also in the middle of selling some securities and which recorded gains during the year. And the real purchasing of securities that were maximizing at this point in time are municipals and they just take time to purchase. And so the ability to leverage the bond portfolio quickly and ensure that we get the yield duration and quality that we're looking for is taking some time. We're continuing to balance the portfolio so it still has a lot of cash flow to fund future loan growth. But we have deployed about $149 million to date back into the bond portfolio at a 5.14% yield. So that as opposed to Fed funds yields that we were getting with the money in just a real short-term investment, we think it will add close to 10 basis points in margin.

Okay. Good. Thanks, guys.

Hey, Mark. This is Joe. I've got another question for you. Because of FAS 141R, when you guys brought over Lincoln, you essentially have to quote, unquote, wipe out their reserves, which is nonsense accounting. You didn't create it, but you have to. When we look at your loan portfolio now, we can see what your stated reserves are. Your reserves at $58.5 million. But how much in Lincoln reserves came over in that process which are now netted against loans?

Well, we brought over $10.7 million in the reserve and we had another $3 million that SOP -- I think 93-3 if I'm -- 03-3, where we did net about $3 million against problem assets. So that -- because we did close the transaction prior to year end, we were able to bring over an allowance. But there was still a fairly large $3 million type number that we had to net against problem assets. But yes, we don't get credit for that in the normal allowance calculation, nor will banks that follow the 141R now that it's in place.

Okay. Mark, thank you.

Thank you, Joe.

(Operator Instructions). Gentlemen, we do have a question from Brian Martin of Howe Barnes. Please go ahead.

Hey, guys.

Hey, Brian.

Some technical difficulties it sounds like. Dave ran through a lot of numbers on those non-performings, and I guess I just wanted to ask him if he would go back over a couple. Maybe didn't even mention the increase in non-performings in the quarter from fourth quarter to first quarter. I know you talked about, Dave, the top five credits and not much changed. But the linked quarter change, can you talk a little bit about what was driving that or just go back over it?

Brian, this is Mark. I may be able to add additional color. The biggest increase quarter-over-quarter was in the other construction and land development category where we saw a $9 million increase. So of the $20 million, $9 million in other construction land development and the remaining amounts were really spread over pretty evenly the rest of the portfolio.

Okay. And on the charge-offs, just a breakout of the charge-offs, what was the largest category of the charge-offs? There was, what, $6 million in charge-offs in the quarter -- what was the breakout of those?

Mostly residential mortgage loans.

Okay. Residential were -- how much were the residential of the $6 million?

$3.8 million, which would include all residential types, whether one to four family, single family and construction and development for single family.

Okay. And the C&I losses in the quarter, what were they?

C&I losses were --

$724,000

Yes, $724,000.

$724,000. Okay. And just in general, I mean, the C&I portfolio, I mean, I guess maybe Mike mentioned or you said it's starting to feel a little stressed. I guess what -- are there certain markets or I guess can you just talk about just the stress you're feeling in that commercial portfolio and where it's at and I guess what areas in particular are you seeing stress?

I can speak a little bit to industry as well as to geography. The most dramatic weakness is really in, without customer concentration, Brian, in the oldest portion of our company, the most manufacturing oriented Indianapolis north to Fort Wayne and all points in between. It coincides with the unemployment spike. Our Commerce National Bank in Columbus which I know you know has a service orientation to it, has really held up probably better in our company and Lafayette has been pretty steady, and Lafayette has the highest concentration of agra business, both production loans and processing and such. That's held up fairly well. So to answer your question specifically, it's middle market companies with some industrial bent to include automotive, from Anderson, Indianapolis, Muncie, Decatur, Wabash markets.

Okay. And just two other things here. The margin in the quarter, Mark, I know you talked about going forward, I mean, the drop linked quarter is just the excess liquidity, is that the primary driver there?

If you include the excess liquidity and then non-accruals, and just look at what I -- the reinvestment of those, we would be more like a 383]. So we went from [387] linked quarter to [383]. And 6 basis points of that is from non-accrual balances. That will not come back. But the other 10 or so that I -- we will be able to recover once the portfolio dollars are reinvested.

Okay.

Brian, I would just ask you in addition to Mark's thoughts to keep in mind that the Lincoln portfolio was at about a 50 basis point net interest margin beneath our historical portfolio throughout its history. So that won't change overnight either.

Okay. Absolutely. All right. And last two things. You gave the breakout, Mark, of the OTTI charge. What was that in the quarter?

We had one $500,000 reduction of an OTTI, I'm sorry, of one of our -- it wasn't one of the pretzels, it was one of the trust preferreds that we had on the books. It was the smallest investment, and we did write that down to the current market value -- which given the discount that those are receiving, was a pretty aggressive write-down.

And just --

There's very little left, in terms of that particular security. I think we have about $22,000 on the books.

Okay. And the last thing, the expenses, can you just talk about what reductions you made in -- it sounded like you talked about a few staff reductions and your outlook on the expenses going forward?

I'll start with a few of the numbers and Mark might be able to help with some of the dollars that are attendant to that. But between the positions that were no longer necessary after the integration, coupled with the changes that we made in First Merchants prior to Lincoln, Brian, it was about 9.4% of our FTE or 129 positions. And so to say that all of those start on April 17th, the date of the integration recorded, would be incorrect, because most of the first merchant changes took place in the month of February, mid February. But the majority of them, although the severances were dealt with earlier, the actual ongoing pay period cost of them, the benefit really starts almost kind of right now, current pay period.

Okay.

And Brian, when I mentioned the severance costs that we had during the year, those costs are related to the First Merchants and changes that we made. The severance costs associated with Lincoln were accrued prior to closing their books. So -- but net -- we have about a 9.4% reduction in overall FTEs.

As far as just the expenses, when they get layered in, part of it's second quarter and the full effect third quarter is the way to look at it?

It's -- we're expecting about $5.5 million at a minimum for the year that really started on the date of integration or the day after integration. So we're really talking about primarily May through December pickup. The run rate in the first quarter all the way through the integration, was significantly higher and also had the severance cost included.

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

Brian, it had severance costs included and it also had the cost of their DP system. There were a lot of different items. When I say a $5.5 million savings for the remainder of the year, it's not just salary and benefits, it is all inclusive of technology, operations, et cetera, occupancy expense.

Okay. Thanks.

Thank you.

Thank you, Brian.

Our next question is from Brian Hagler of Kennedy Capital. Please go ahead.

Hey, good afternoon, guys.

Hi, Brian.

On your non-performing loans, I was just wondering, can you tell us what the average mark is you've taken on those assets?

Well, I think you can -- hi, Brian, this is John Martin. I think if you look at the statement with respect to the specific reserves as a percentage of the allowance, you can start to see how it fits into the total. I would say our discounts on those are on a case by case basis. We analyze the collateral by obligor, and it can be, depending on what the collateral is on a particular transaction, much higher, much lower. I don't think we could necessarily give a particular average.

And as John mentioned, the specifics, right now it's a 14% balance in specifics today and some of these loans have already been marked -- we've taken some charge and they remain in the non-accrual category. So --

Specific impaired probably understates the amount of impairment we've already recognized.

That's correct.

So 14% of your total reserves today are specifically allocated? Is that what you're -- ?

No, it's $14.5 million of the reserve, of the $58.5 million reserve are specific.

Okay. Got you.

$14.5 million of specific reserves divided by our non-accruals of $108 million is the 14%.

Got you. Okay. Secondly, leads me to my next question. Have you guys looked into or would consider selling some non-performing assets or participating in the asset purchase plan?

In the structured asset purchase plan, the PPIP, we would be interested in that. As you've seen, the momentum for that program as slow as I think buyer interest is in the -- what appears to be $0.30 to $0.40 range and seller interest is usually well in excess of that. Our interest would happen to be in excess of that as well. We've been really more interested in -- we've had a limited history, Brian, with asset sales, distressed asset sales, and we've continued to explore those channels. But they're slow and -- be more an specific answer, we have not done any. We have none planned at this point.

All right. Great. Thanks.

Thanks, Brian.

Thank you. We have a follow-up from Brian Martin of Howe Barnes. Please go ahead.

Just one thing. David, you talked about those top five relationships. Can you just give us an update as far as where you stand as far as resolution on those and just timing?

Actually, the largest C&I issue that we have, we have some near term conclusions on that where those assets are going to be purchased by another company, and so that should improve dramatically. The one that I maybe mentioned in the past quarters and I think you remember when I talked about a development in Western Delaware County, that is soon to be resolved in part as we have a new corporation moving to Muncie to buy some land and our spec building that was there. And so we should be in very short order, probably with at least 120 days receiving a reduction in [that] loan by over $3 million.

So those reductions total, ballpark, how much out of -- ?

Out of all that, that's roughly $7.3 million.

So about $7 million get resolved over the next couple quarters?

Exactly.

And that's two of the five?

That's two of the five.

Any update on the others or just slower going?

It's a little slower going. One is a residential development, actually two of those are residential developments. So the absorption of those could continue to be slow as we've seen in all the markets. So I can't say that it's going to happen overnight. We've got some plans to reduce part of those but it's going to be slow going.

Brian, it's Mike. We entered into a sale agreement for individual lots on one of those projects that doesn't move the loan off of our portfolio.

Okay.

But the demand from the home builders, particularly in the lower end non-custom built area, has enough life in it that most solvent home builders are at least looking at their own really modest inventory levels and trying to at least make arrangements to supply themselves with lot inventory, but nobody wants to buy it in bulk from us or from anyone else. So I think it's going to trickle out as individual home contracts are executed.

Okay. And just lastly, I don't recall who of you talked about it, but you mentioned that when you looked -- maybe it was you, Mike, as far as the second wave of credit issues that came about, just with the commercial customers just being a little bit worse than you thought, I guess. What was it that I guess that -- maybe if you could elaborate on that a little bit, I guess it would be helpful.

Well, it's this. I hope you see it elsewhere. I would hate to feel like First Merchants is that unique. It's that operating in the middle market and lower middle market with those clients, it's more typical to get reviewed statements than audited statements and it's more apt to get them 100 days after the period end than 60 days after the period end. And so the creep, if you will, was the mid February to mid April receipt of a lot of financials where we knew that people were struggling. And if you might call them watch list, if you will, based on their industry orientation, the receipt of the numbers prove them to be worse than watch list. That's what I'm saying.

And that was in the C&I. So the C&I, they weren't in the losses, per se, in the net charge-offs, but they were in the increase in the non-performing assets.

Yes, and with our reserve calculating it calls for provisioning and all of that. Well, also, the numbers are getting -- the numbers that Mark included that speak to some of our collection cost outside of loan provision, the legal representation and the OREO costs are just meaningful six figure numbers.

Because Mark said, I guess the linked quarter increase in the non-performings was $20 million total, $9 million was CMB. Was a good chunk of the remaining from the C&I book?

It was actually -- there was a $4 million increase in the non-farm, non-residential, owner occupied and $4 million increase in the owner occupied sector.

Okay. Both the same. Okay.

Owner and non-owner, $4 million apiece.

Thank you, guys.

Thank you, Brian.

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

Thank you, Andrea, I have very few. I thank you for the quality of the questions, the quality of your interest. Feel like we have a lot of momentum that will become easier to see in our financial results. We're hopeful of that. We're committed to it. We look forward to talking to you again at the conclusion of the second quarter.

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