First Merchants Corp (FRMEP) 2013 Q4 法說會逐字稿

Good afternoon and welcome to the First Merchants Corporation fourth-quarter 2013 earnings conference call. (Operator Instructions). Please note this event is being recorded. We will be using user-controlled slides for our webcast today. Slides may be viewed by following the URL instructions noted in the First Merchants news release dated Tuesday, January 28, 2014, or by visiting the First Merchants Corporation shareholder relations website and clicking on the webcast URL hyperlink.

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 risks 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.

I would now like to turn the conference over to Mr. Michael Rechin, President and CEO. Mr. Rechin, the floor is yours, sir.

Thank you, Mike. Welcome everyone to our earnings conference call and webcast for the fourth quarter ending December 31, 2013. Joining me today as always are Mark Hardwick, our Chief Financial Officer; and John Martin our Chief Credit Officer.

We released our earnings -- I hope you have them -- in a press release at approximately 10:30 AM Eastern daylight savings time earlier today, and our presentation speaks to the material from that release. The directions that point to the webcast are also contained in the back end of that release, and my comments will begin on page 4 on a page titled First Merchants 2013 performance.

So I thought I would speak to both what I view as our highlights for the full year and then touch on the fourth quarter before I look to my colleagues to provide some of the detail of both the results as it relates to the financials and then some of the credit metrics behind those results.

As I said in the press release, we reported that First Merchants had earned 2013 record net income available to common shareholders of $42.2 million compared to $40.6 million that we earned in 2012. Full-year 2013 earnings per share totaled $1.41 identical to 2012. And as you can see in the release, we got to $1.41 in a different way.

In 2012, our results included a one-time $9.1 million or $0.21 per share gain associated with the FDIC purchase of Shelby County Bank, whereas in 2013 that same $1.41 total was after recognizing the expenses with bringing an important acquisition into our Company by way of Citizens Financial. And the expenses associated with that, roughly $5.4 million of one-time expenses, are included in those earnings, which were heavy in the fourth quarter as we got to a close.

So, we are pleased with that. Other highlights for the year in my mind are a improvement in our overall capital structure. I thought we had a effective debt transaction that closed November 1 issuing $70 million, which was a combination of $5 million in senior debt; $65 million in sub debt that effectively refinanced what had been our subordinated debt and fully redeemed our remaining small business lending fund shares into a new 15-year sub-debt financing, replenishing our level of Tier 2 capital.

Earlier in the year, we, through strength of earnings all through 2012 into the early part of the year, our Board chose to increase the common dividend from $0.03 to $0.05 per share. So I think for our shareholders, it proved to be a good year.

Our market cap between the performance, the acquisition, the shares that were issued as a result of the acquisition. Our shares grew from $14.84 at the beginning of 2013 ending at $22.70, and our market cap is the bullet point on the slide shows grew 90% from roughly $430 million to $815 million. So, we are pleased with a lot of that activity.

The fourth quarter is highlighted on the bottom of this page and highlighted throughout the release where we earned $11.2 million in net income versus $9.2 million in the like period fourth quarter of 2012; $0.34 in the current period versus $0.32 a year ago, and included, as I referenced earlier, the bulk, 80% of our acquisition expenses, $4.5 million, which Mark will speak to, included in that $11.2 million current period result.

Spent months of collaboration, culminating in our November 12 closing having received all the necessary approvals to bring the Citizens franchise into First Merchants and begin the next chapter of our Company's history.

We are pleased and I think we talked about it the last earnings call, the consistent view of the asset quality that we saw coming from Citizens' balance sheet and their loan portfolio and investment portfolio.

Took six months roughly to close. We spent significant amount of time with our new colleagues and the portfolio. Our view at closing and now is that in the transaction pricing, very appropriate as a value for our shareholders.

Fourth line item is that while the Citizens acquisition and the closing was a high priority, the balance of the Company stayed focused on the market and our clients. We had our strongest loan growth quarter of the year in the fourth quarter, 3.5% on a standalone basis, just over that. We are pleased to see that our clients continue to look for First Merchants for solutions.

At this point, I'm going to turn the program over to Mark to dig a little bit deeper into the financial results.

Thanks, Mike. My comments will begin on slide 6. Investment portfolio on line 1 increased by $222 million as deposits acquired in our CFS merger exceeded net loans by $359 million, creating excess liquidity to invest. Portfolio loans on line 3 increased year over year by $730 million and now total $3.633 billion.

Pre-merger balances increased by $133 million or 4.6%, and CFS loans totaled $597 million. The allowance on line 4 totaled $68 million or 1.87% of loans; however, John will detail the fair value adjustments and the allowance coverage of pre-merger loans later in the presentation.

Goodwill and CDI increased by $53 million during the year, reflecting the difference between our $136 million purchase price and the net assets acquired. CDI totaled $7.3 million and will amortize over 10 years. Bank-owned life-insurance increased by $40 million during the year due to the acquisition and improvements in the cash rendered value policy during the year.

The nearly $100 million increase in other items includes approximately $22 million of fixed assets, $26 million of our deferred tax assets, $17 million in interest-bearing time deposits, and $9 million of other real estate. All of the increases are related to the CFS merger.

The composition of our $3.6 billion loan portfolio on slide 7 continues to be reflective of a commercial bank, and it continues to produce strong loan yields. The portfolio yield for the third quarter totaled 450 -- I'm sorry, for the fourth quarter totaled 4.55% compared to 4.52% in the third quarter of 2013. Fair value accretion totaled just $638,000, including a $164,000 from CFS for 45 days.

On slide 8, our $1.1 million bond portfolio continues to -- billion dollar bond portfolio continues to perform well, producing higher than average yields with a moderately longer duration than peer. Our 3.82% yield compares favorably to peer averages of approximately 2.58%, and our duration remains just 10 months longer totaling 4.3 years.

Prior to closing CFS merger, the CFS management team sold nearly 100% of its securities, which averaged approximately 1.5 years in duration and yields that range between 1% and 2%.

Post merger we worked for 45 days to reinvest the cash at yields of 3.6% with a duration of just over 5 years. The decision allowed for a clean close and go-forward securities that were consistent with our portfolio and investment style.

Now on slide 9, non-maturity deposits on line 1 are up $797 million and represent 78% of total deposits. During the quarter, we also refinanced our $50 million subordinated debentures that had a February of 2015 maturity date.

The refinance was achieved by issuing $65 million of new subordinated debentures with a 15-year term and are not callable for the first 10 years. And it's a fixed obligation for those 10 years with a 6.75% interest rate. The $15 million balance differential is highlighted on line 6.

Additionally during the year we paid back the full amount of our SBLF lending fund obligation totaling $91 million is reflected on line 7 and $34 million of that was during the fourth quarter. The SBLF dividend was going to increase from 5% in 2013 to 7% in 2014 and was not tax-deductible. So the entire transaction was accretive to 2014 net income and more importantly allowed First Merchants to close the year with an optimal capital structure post integration.

Line 10, tangible book value per share was the focus of my quote in the press release and deserves some discussion. As of September 30, 2013, our tangible book value per share was $11.56.

During the quarter, net income and other comprehensive income improved tangible book value per share by $0.74. It was a combination of earnings and primarily the improvement of the assets that are part of our pension plan that is currently frozen, but the assets performed well creating an increase in OCI.

We paid a dividend of $0.05, which would've resulted in tangible book value per share of $12.25 without our acquisition. As a result, the dilutive effect of the acquisition was $0.08 per share or approximately the first five quarters of earnings accretion, meaningfully shorter than the three years that was announced in May.

As I previously mentioned, the mix of our deposits on slide 10 continues to improve and it's comprised of 48% demand deposits and 30% savings deposits, our least expensive categories. Total interest expense on those deposits is now just 31 basis points, down from 35 basis points as of last quarter.

Slide 11 is a new slide for us and it highlights the results of our capital actions over time. 2013 strong earnings, combined with our debt refinance and the merger of CFS, produced year-end capital ratios that are above our target levels.

The Corporation's net interest income on slide 12 increased as expected due primarily to 45 days of CFS performance. The increase in our cost of supporting liabilities during the quarter is due to the debt refinance. The new debt has a higher balance and is more expensive than the old instrument and is now reported as interest expense above the line, whereas the savings from paying off the SBLF is reported below the line.

Total noninterest income on slide 13 when normalized for line 7 and 8 improved by $1.5 million during the year and does include the impact of CFS for 45 days.

Noninterest expense on slide 14 totaled $143.2 million for the year, up from the prior-year total of $137.1 million. Included in our 2013 results are $5.4 million of acquisition expenses, as Mike mentioned previously, including $2.5 million of severance expense, retention packages, and FICA tax and more than $1.5 million in contract terminations and data conversion expense. The remaining amount is made up of professional expenses like banker fees, our lawyer fees, and our accounting fees.

EPS on slide 15 totaled $1.41. Higher and net interest income online 1, reductions in our provision expense on line 2, and lower SBLF dividends on line 9 allowed us to overcome last year's FDIC gain on line 4 and this year's acquisition expense.

So the combination of better net interest income, lower provision, lesser SBLF dividend, more than allowed us to make up for the difference of the FDIC gains from a year ago, and it also allowed us to carry the acquisition expense for the year.

Now on slide 16 you will notice our adjusted annual EPS over the last three years has increased from $0.80 in 2011 to $1.09 in 2012 and now totals $1.36 on an adjusted basis where the reported numbers are $1.41 for 2013.

John Martin will now discuss our loan portfolio composition and related asset quality trends.

Thanks, Mark, and good afternoon, everyone. I will be covering the loan portfolio trends on slide 18, then discuss year-end asset quality before closing with a look at the allowance in fair value coverage that Mark mentioned earlier before turning the call back over to Mike for his comments.

So turning to slide 18, slide 18 highlights the impact of the recently acquired CFS portfolio and the combination of balances. We experienced balance growth in the portfolio resulting from both the inclusion of the CFS portfolio as well as organic growth.

On line 1, commercial and industrial loans increased $139 million, which includes $57 million of First Merchants growth from 2012 to 2013. Construction lending on line 2 increased $79 million for the year, which included $64 million of First Merchants growth. And on line 3, non-owner occupied CRE increased $257 million, which included $53.5 million of First Merchants growth.

This resulted in an increase in First Merchants' originated loan portfolio $133.5 million or 4.6%, and on a combined basis the total portfolio increased $730.2 million or roughly 25%.

Before I speak further to the changes in the First Merchants originated portfolio on slide 19, I'd like to mention the composition of the overall combined CFS and First Merchants portfolio. The combination of the portfolios, while increasing total loans by 25% I just mentioned on line 11, neither increased or decreased any one segment of the portfolio by more than 3% on a proportional -- as a proportion of total loans with most categories having a percentage change of less than 1%.

The similarity in the acquired portfolio should allow us to apply our existing asset quality strategies and tactics as we work through the portfolio.

So turning now to slide 19, carrying the discussion from the prior slide forward, I would just highlight lines 1 through 3 where starting on line 1 in the linked quarter commercial and industrial loans increased $109.4 million, which includes $27 million of First Merchants growth.

On line 2, construction lending balances were up $27.2 million where First Merchants balances contributed $12.5 million, and then on line 3 non-owner occupied commercial real estate was up $262.1 million with First Merchants contributing $58.5 million to the increase.

We continue to build a dynamic construction lending portfolio and saw seasonally sizable increases in growth in the portfolio as we continue to see strong demand for multifamily and student housing.

As mentioned in previous calls, construction lending on line 2 and non-owner occupied real estate on line 3 are being driven by project funding during the construction phase with the balances moving to either the permanent market or into the Bank's loan portfolio at completion.

We expect to see the CRE portfolio continue to ebb and flow while trending positively as projects fund, stabilize, and move both to the permanent market and into the portfolio.

Now turning to slide 20. The trend for asset quality for the year was favorable, focusing on the FMB 2013 column, which excludes the CFS portfolio, on lines 1, 2 and 3, nonaccrual loans, OREO and renegotiated loans, respectively, were all down. 37%, 30.1%, and 76.4%, respectively for the year.

On line 5, NPAs to loans and ORE had a percentage percent decline of better than 1% for the year and continue at favorable trend is the economy improved and we were able to move troubled assets.

Moving to the column labeled CFS, the addition of $22.7 million of nonaccrual loans on line 1, $12.9 million in ORE on line 2 and $95.4 million of criticized assets on line 7 is optically similar to where we started 2013 and on a percentage of loans is better than where we started the year.

So then moving on to slide 21 in the column labeled FMB 2013, which combines the quarterly changes for last year. This slide shows where the improvement of asset quality occurred.

On the line 2, the First Merchants originated portfolio and that same column generated $23 million in new non-accruals while moving out -- while we were able to move out roughly $43 million to pay off and refinance, restructure ORE and charge-off. This resulted in a net decline on line 6 of $19.7 million.

Skipping down to line 13, the NPA change was $34 million, which for the year resulted in a roughly 42% decline in NPAs and 90-plus day delinquent loans. As just mentioned on the last slide, including the CFS portfolio, asset quality is essentially where FMB started 2013, which can best be seen starting on line 13 to the bottom of the far right column from 2013 at $83 million as compared to the top of the column on line 1 where we started the year at $81.4 million.

So now turning to slide 22. The fair value accounting for the addition of the CFS portfolio impacted the allowance coverage to nonaccrual loans, which is highlighted on the graph on the top of slide 22.

As is easily seen, the effect of the fair value accounting pushed the allowance coverage to the nonaccrual loans down to 120% in what is a new basis for this measure. Even so, the coverage remains in line with the year-ago levels and is well in excess of 100% of total nonaccrual loans.

And then on the bottom of slide 22 the recovery of payments on prior charged-off B notes and payments of other smaller charged-off notes resulted in net recovery of $630,000 for the quarter. For the year, net charge-offs were $8.1 million or 0.27 -- or excuse me, 27 basis points of average loans.

And then finally turning to slide 23, this is the new slide for the quarter highlighting the allowance coverage and the effect of fair value accounting on the allowance. On a combined fair value and allowance basis, portfolio coverage is 3.19% on line 7 in the bottom far right column. This coverage includes on line 2 $9.8 million of fair value adjustments to the Shelby County Bank portfolio and $39.6 million on the CFS purchase portfolio. And it helps to really provide a comparative basis to our historical allowance coverage.

So then I guess I would just closed by saying that, before I turn the call back over to Mike, that the portfolio continues to tread favorably in asset quality. Our construction pipeline remains strong and our original credit outlook for CFS is in line and somewhat better than our original analysis, which positions us well entering 2014.

Thanks and I will turn the call back over to Mike Rechin now.

Thanks, John Martin. On page 25, I'll offer some thoughts on the bullet points there before we take questions. And just start my forward look on 2014 by stating we're going to stick to our plan. We've got a multiyear plan that's really well communicated inside our company for roles and responsibilities. It's a difficult operating environment, but the plan has served us well so we are going to stick with it.

A signature event is 30 days out. We're spending significant effort at this point in thorough preparation for our integration that's less than 30 days away. And our goal is the second bullet point speaks to is for client retention and implementing growth tactics.

Our goal is to pique the interest of the customers, clients, prospects in those in new marketplaces, thus through the same faces and same names that those folks have come to trust over time. We are off to a good start with this. We look for that to continue.

We are seeing the experience, the management skills, and the leadership from the Citizens team that has joined First Merchants. We look for that to continue. It gives me great confidence for the -- extensive change event that's directly in front of us.

In that bullet point you'll see in brackets the term Lakeshore region. My guess is that in future calls, you'll hear less about Citizens Financial by name and more about our Lakeshore region, which is been named inside of First Merchants as the signage change scheduled for the end of February will be part of that integration effort.

We are on target for the expense savings that we talked about in May. Whether it's contracts, vendors, technology, and talent decisions, they are all in place. During the second quarter we ought to get to that operating expense run rate that we forecasted in May, which you may recall was for 30% reduction once the changes had taken place in the overall expense rate of the Company.

I look for our Chief Banking Officer to continue our again a growth initiatives throughout the entire franchise, continue the momentum that we have.

I'm pleased that in the fourth quarter some of our fee levels, particularly in the non-banking businesses, insurance and trust, were up. Treasury management are up, offsetting the slowdown that I think most financial institutions have seen in the mortgage business.

So if we can get any resurrection in mortgage volumes into the spring, coupled with the momentum that the businesses I just mentioned have, I think we have a good chance to have our non-interest expense continue to show life. We're going to emphasize market coverage. We are available to help our clients grow.

Less significant and not jumping out of a line item is our continued assessment of our retail franchise. We're looking at our distribution system. In this past year we did a couple of banking center combinations whereby we build a new banking center to close two. It's not our favorite activity, but we think there's opportunity for that going forward.

We have a couple of growth market banking centers that are going to open up here in the first half of the year. We are excited about. We'll have activity that will be evaluating right behind that that may or may not mean more banking centers but would be geared towards client service and efficiency.

And we look at this opportunity with Citizens joining us, our Lakeshore region, as more than an acquisition. It important growth market to us. It reminds me in some respects of five years ago when we acquired Lincoln Bancorp which was another recently converted thrift that had a stockpile of commercial bank talent that became part of our Company and helped us build what is our best growth market today in terms of loan growth results in Indianapolis. I liken that to what I see up in Citizens, and I'm looking for the management that of joined us there to help us execute in a similar fashion.

Lastly, we're going to look to continue to leverage that integration experience, management depth, technology platforms, and our culture, if the market allows us to do so. We will balance those ambitions with discipline in market choice and in pricing, and hopefully whether it's in 2014 or past that have other opportunities to take advantage of the consolidation of the business while our customers stay forefront in our mind.

So John and Mark and I are all available for questions. And at this point, Mike, if you're still with us you can open up the mic and we'll take those.

(Operator Instructions) Scott Siefers, Sandler O'Neill Partners.

Mark, I guess first question is probably best for you. Can you talk a little bit about how you see the margin trending over the next few quarters. I guess the adjusted margin was down about 10 basis points to 383 and I guess going forward you'll have the full quarter benefit of the purchase accounting adjustments from CITZ. So maybe just any thoughts you have on level either adjusted or reported going forward and what you think the major puts and takes will be?

In this quarter we only had Citizens for 45 days, but their core margin was running materially less than ours what 330? We've made some pretty significant changes in our bond portfolio and increasing those yields from 1.5 to 3.5.

But in the fourth quarter we were still purchasing investments, and I would say we probably because of the time that that took left about $225,000 of earnings on the table as we were transitioning.

The other, I think, key item, we had $164,000 of purchase accounting accretion that came in in the fourth quarter just related to CFS, and I'm anticipating that that is a $500,000 a quarter type of the number absent any activity around the non-accretable yield section. So, we have a little -- right around $14 million that is in accretable. The remainder of our marks are in the non-accretable section. It takes a payoff before that comes back in.

So in our -- the FDIC transaction from last year, at Shelby County we were surprised how fast that that came back. But it's a troubled institution, and we are not anticipating that the marks we have today will come in quite as quickly. And they also are there to absorb losses. That's I guess on a go-forward basis kind of how I'm viewing it without giving you a specific margin number.

And then was there a second question?

No, that got the first part of it. So I appreciate that. And then I -- just wanted to switch gears a little and I apologize if I missed this in your comments on capital. But can you talk a little bit about tangible book and capital levels? I guess I would've anticipated they'd come under a little pressure given the closure of the deal, but they were both up.

So how are you thinking about sort of the pro forma level, the earn back period you had articulated when you originally announced the merger, et cetera?

Well we originally were expecting about 3% dilution, which would've been about a three-year earn back based on the accretion that we've layered in which does accelerate after the acquisition and into the second year. And that's mainly because of some balance sheet growth that we are anticipating in the second year. Year one we weren't anticipating growing the balance sheet just as we are working through some of the problem credits. The --

So it's effectively -- Scott, I think I heard your question as well. It's effectively a one-year, five-quarter kind of a recapture versus the 11 or 12 quarters that our initial modeling contained that we shared a few months back.

Yes, sorry about that, I lost my train of thought for a moment. The $11.56 where we start in the quarter did improve -- the question you were getting to is the OCI was such a dramatic change in the first quarter that it produces a result of the end of close that looks materially different than we anticipated.

But the other half of that -- and it's going to equally split -- is because of our fair value marks weren't as deep in the loan portfolio. More like $40 million instead of $52 million. And the core deposit and tangible was more like 7 instead of 11. So we had a couple of nice pickups there that help to strengthen the tangible book value per share post closing.

Okay, perfect, I appreciate that color. And then I think just the last question I have is on the tax rate. It bounced around a bit over the last several quarters. I think it's been as high as 28% and as low as 20%. What kind of tax rate should we be using for our models here as we look out over the next year or so?

Well, we've had a couple -- well, two quarters in a row with fairly sizable, low-income housing tax credit type of deals that were finalized. And so, it created a little bit of -- especially last quarter -- a sizable loss or a negative income in the noninterest income section offset by a big tax adjustment. We had a similar adjustment the fourth quarter.

The effective rate going forward is -- 27% is more of an effective tax rate that you could expect on a go-forward basis. Really 35% applied to everything after you deduct out our tax-free income from bank-owned life-insurance and our tax-free munis. That's more of a standard.

Okay, perfect. I think that does it for me. So I appreciate it.

John Barber, KBW.

My first question was related to the loan mark. In your press release you talked about a $40 million loan mark. And I just wanted to make sure I'm comparing it correctly compared to your initial expectations that there would be a $52 million loan mark. I guess what was the difference there and what improved?

Hi John, this is John Martin. The -- when we went into it, we did our due diligence. And one of the things that we do is order appraisals. And as we started to receive those back on both the ROE balances as well as the classified, we went through and ordered to appraisals on virtually every classified asset as well as number of the criticized assets as well to get refreshed and updated appraisals on the values that we had that helped drive the marks on the SOP, the non-accretable portion of it.

We're better than what we had initially done in the due diligence. We set those marks with a fairly aggressive or conservative stance not knowing what we'd see back. As we got it back, we adjusted.

Thanks for the color. As it relates to the deal, are there any revenue enhancement opportunities that you are seeing that maybe weren't as apparent a couple of months ago?

It's early but the opportunity that we saw two quarters ago at the front end of the announcement and today are the same. It was a very traditional spread dominated banking company absent, at least in our case, a trust business or an insurance business. So the introduction of those capabilities have begun. I feel like the competency and talking to their clients about them will grow over time.

We don't have a lot of that factored into 2014. As we get the training in place to bring those capabilities to life. Outside of those two businesses, John, we've been proficient in using swaps for instance with our commercial clients which is we think an interest rate management technique that they are clients would benefit from. But those two primary nonbanking businesses would be our greatest upside at this point.

All right, thanks Mike. And the last one I had was just related to deals. It's kind of a two-part question but the first part is you identified capital target ratios. I'm just wondering if the right opportunity came along how your willingness to go below those target levels. And then just a second kind of part of the question, we've seen a couple of deals announced recently. It looks like pricing for some but not all deals are firming a little bit. Talking about 1.8 or 2 times tender book value, that level.

Does that raise sellers' expectations or does it make maybe banks look at potentially selling as a more attractive option? They look at that price and say it's pretty good and will maybe think about selling. So any comments to those questions would be great. Thanks.

Well the first half of your thesis on -- does it raise seller expectations? I think that is clearly the case. We are not involved in all that many active discussions, but anyone that would be looking at that potential would look at the last handful of transactions that took place. And so that is disappointing a little bit because I haven't seen in our opinion the value on the other side of that price that would make you feel great about the prices going up as much.

Well, our currency is up, which does help. Obviously, creates a higher deal value for the same number of shares. So, I think all the deal values are increasing as bank stocks rise. The comment about capital. Those are not hard minimums.

I would imagine that if the right deal came along with the proper tangible book value earn back that we would allow those numbers to drop below 8% modestly and then quickly return back to those levels better than the target.

Thanks for taking my questions.

Stephen Geyen, D.A. Davidson.

I think I missed this, but I think that was about $5.4 million in acquisition-related expenses, $2.5 million in severance, $1.5 million in contract termination. Just wondering where the other portion came in on the income statement? What it was?

Yes, it was $2.5 million if you look just -- [let's look forward] for the year. $2.5 million in salary and benefits. We had a couple hundred thousand dollars in equipment and over $2.5 million in the other category that was made up of whole set of items.

Investment banker fees, legal fees --

Contract terminations that we mentioned already.

And for the quarter? What was the amount?

It was $4.5 million for the quarter and the same $2.5 million in salaries and benefits, the same $196,000 or $200,000 in equipment. And then a little over $1.7 million in other that was the same type of things, just slightly lesser amounts. And it happened in the fourth quarter.

Okay, perfect. And as far as the you had mentioned the 30% reduction. That's going to be fully in in the second quarter of 2014?

It will probably be end of the third quarter for certain. We have a calendar that kind of lays out when we realize those expense savings. Some of them have taken place already. The heaviest one relative to FTE really begins to hit in the May timeframe because we keep a full team of folks effectively in place through integration and about a month after integration to make sure it was done well. But yes, by May on a monthly basis, we'll be in good shape.

We have yet to recognize -- about $6.5 million of the savings. That all happens post integration.

Okay, perfect. And -- I'm sorry?

$6.5 million on an annualized basis.

Got it, got it. And you had talked a bit about the construction pipeline. Typically those loans are going to stay on the books for maybe a year, and then it's a question of where they go. Do they go to the permanent market or stay on the balance sheet? What he think the likelihood is being able to retain some of those loans?

I think we've got a balance. We underwrite them to the secondary market, and I see the construction pipeline continuing to be stable and maybe trending upwards. But in terms of retaining it in the portfolio really depends on the -- what the investors objectives are. I would say a percentage of them will stay on the balance sheet, but I wouldn't expect that to have a huge jump.

The terms of the permanent market are -- this is Mike again, Steve. The terms of the permanent market are attractive to our clients. And so, we feel like once those projects stabilize, which is in my mind more like two years rather than one, they ought to qualify for nonrecourse permanent financing at rates that we typically wouldn't want long term on our balance sheet. It also gives us more capacity to work with those same clients on additional projects or other clients. So it's -- that flow, we're kind of pleased with.

Okay, all right, good. Last question on the commercial and industrial. Just curious if you have kind of a broad view from your customers as far as what their outlook is for 2014?

I think it's guarded. We view -- I mean I welcome the chance to compete not only in our existing franchise but up north.

I think our clients are guarded. I think they all had fairly successful 2013's and much like this time last year are trying to digest the change in front of them. I'm pleased -- I saw Indiana unemployment numbers came down again either yesterday or today. It's got to help people out.

I think healthcare needs to be understood on a broad basis, but I would hope that the spring is going to be optimistic and replenish our pipeline. We -- our pipeline is a little bit lower than it was the beginning of the fourth quarter but not by a whole heck of a lot, and we had a very strong quarter. So sometimes we pick up on volume on a usage basis that never actually is in your pipeline just on greater utilization.

Great. Okay, thanks for your time.

Brian Martin, FIG partners.

Mike, just following up on the last question. Would your expectation be with kind of better momentum in the commercial side that maybe the overall loan growth organically in 2014 is little bit stronger than it was in 2013? Just economically are things getting better?

Well economically, yes I would like to think that the fourth quarter would be a favorable look forward. A couple of things go to offset that. One is that was a 14% plus or minus annualized run rate. I don't expect that in 2014.

We have a couple of drags. One of them would be we do have with the $600 million of Citizen loans, some asset quality remediation that I think will take place by virtue of a client finding another place to do business. So, I think that will offset a little bit. Having said that, all of the horsepower in that Lakeshore region is geared towards getting out and telling the First Merchants story.

On a legacy First Merchants, our core business, I think I'm going to give you the same look that I did this time last year, which is that a mid- to high single-digit number is what I believe we can achieve based on what we see in the market.

Okay, all right and then maybe just to housekeeping questions. Were there any outsized OREO gains in the quarter? Just kind of looking at that fee income number; it seemed a little bit stronger than I had thought. But was there anything in there that was unusual this quarter and if you could comment on that?

And maybe Mark, just -- maybe I didn't catch what you said about the discount accretion that rolls through. I think it was $600,000 or so this quarter. If you gave some color on what that was prospectively, how you're thinking about it, that would be perfect.

I think, Brian as far as the OREO number is concerned, we did have recovery in the quarter. As you saw, the portfolio, the OREO portfolio go down from 12 to 9 in the FMB core. It was a $2 million or so that we took back in the income.

And the fair value accretion, we had -- it was $164,000 for CFS just for 45 days, and I would anticipate around $500,000 a quarter absent any pay downs on the non-accretable portion of the portfolio. So, that assumes about a five-year amortization of the accretable yield.

That's helpful and then maybe just one last thing for John. The organic loan growth you guys achieved in 2013 from the Indy market, how much of the 133 inorganic was tied to Indy, and where do the Indy balances stands today?

Well, our balance for the Indianapolis region at year end is $1.1 billion. As it relates to the organic growth in the fourth quarter, I don't have a specific number. Actually I do. I can speak to the closings in the central region, which is what our moniker is for Indianapolis, but that doesn't really relate to the net balances.

Okay, all right. That's fine. It's not necessary then. Thanks, Mike.

Daniel Cardenas, Raymond James.

Just maybe going back to M&A. Maybe if you could speak a little bit as to what the chatter is? Is it picking up in the state? Just given how fresh you are off of this deal -- how soon do you think you could go back into the market and do a deal if it was the right deal?

Pretty quickly. I feel like the barbell of work that goes into this integration would be on one end and that hasn't taken place yet. But the upfront work on getting to know management teams, doing preliminary due diligence, reaching some kind of a general agreement on value, and then understanding that the approval process is six months long, I would tell you that if you back up from that we would be able to move in the current time period, if you found something suitable.

Okay, excellent. And then in terms of expectations, I may have missed it. You may have said this before. But are seller expectations stabilizing here or are they still beginning to pick up in terms of (multiple speakers)?

You would have as good a perspective as I do, but I think they have to be moving up between the -- there was a Fort Wayne transaction announced that was rich, fully priced I would say. Everything I've seen would suggest that the kind of price or value that we were able to find for a $1 billion bank in Citizens would be hard to come by again, coupled with the talent in that bank and the quality of the marketplace.

Okay, fair enough. And then as you think about potential expansion, would it be primarily in the Indiana marketplace, or would you be willing to maybe build up your presence in Illinois and Ohio or perhaps enter into another market altogether?

I would answer consistent with that question in time past which is any of the states contiguous to Indiana, Kentucky, Ohio, Illinois would all have interest to us, perhaps even Michigan although we haven't spent a lot of time looking in that. But the other three, in addition to which rounding up is still a significant amount of market attractiveness in my opinion in Indiana. But clearly down state Illinois, central Ohio, southern Ohio would be very attractive.

Okay great. Thanks, guys. Good quarter.

At this time, we have no further questions. We will go ahead and conclude our question-and-answer session. I would now like to turn the conference back over to management for any closing remarks. Gentlemen?

Hi, it's Michael, I appreciate your hosting the call. I am thankful for the long-term interest in our performance and look forward to talking to you again in a couple of months when we have a little bit more clarity as to how all of our integration efforts come together in the first part of 2014. Thank you all.

And we thank you, sir, and to the rest of the management team for your time today. The conference call has now concluded. We thank you all for attending today's presentation. At this time, you may disconnect your lines. Thank you and take care.