First Merchants Corp (FRMEP) 2015 Q4 法說會逐字稿

Good day, everyone, and welcome to the First Merchants Corporation fourth-quarter 2015 earnings conference call.

(Operator Instructions)

This presentation contains forward-looking statements based on our current expectations reflecting various estimates and assumptions. These forward-looking statements include, but are not limited to, statements relating to our business outlook. These forward-looking statements are subject to significant risks and uncertainties that may cause results to differ materially from those set forth in this presentation, examples of which are included in the written presentation materials filed with the Securities and Exchange Commission in connection with this call. Please refer to those materials for a more detailed discussion of the applicable risks.

Please also note, today's event is being recorded.

At this time I like to turn the conference call over to Mr. Michael Rechin, President and CEO. Sir, please go ahead.

Thank you, Jamie. Welcome, everyone, to First Merchants' earnings call and webcast for the fourth quarter ending December 31, 2015. Joining me on the call today, as is our tradition are our Chief Financial Officer, Mark Hardwick; and our Chief Credit Officer, John Martin.

The company released our earnings in a press release, about 10:00 AM Eastern Daylight Savings Time, and our presentation webcast speaks to material from that release. The directions that point to the webcast were also contained at the back end of that release, and my comments begin on page 3, on a slide titled fourth-quarter 2015 highlights. I take that back. It's actually titled 2015 performance and full-year highlights at the top of the page.

And, we announced record 2015 income, net income of $65.4 million, an increase of $5.2 million over 2014's net income of $60.2 million. Earnings-per-share totaling $1.72, an increase of $0.07, or 4.2% over 2014's earnings-per-share of $1.65. In that top section on slide 3, a couple of other, what I think of as signature events, summarizing our performance for the year, including a 20% increase in net loans, which is inclusive of two acquisition closings that incorporated the organic loan growth at the high end of the range that we've talked about on these calls throughout the year. And an overall really satisfying acclimation of new franchises into ours at First Merchants.

The successful integration of Community Bank and Cooper State Bank I referenced just a moment ago, two acquisitions. Those would've been Cooper State Bank earlier in the year and Ameriana, which closed at year end. We also completed two integrations, one of them for Cooper. All of that work being completed in the last 12 months, and then November of 2014's legal closing of Community Bank actually integrated in the first -- early in the second quarter of 2015.

And when I talk about successful integration, it might suggest technology overlap and data integration, it does. It does include those. It means more to us. It's an integration effort that we work on calls for a smooth changeover event, a retention of clients, retention of talent, and each of those two events would fit that definition, as have the acquisitions that we've learned from and integrations we've learned from in prior years.

Next bullet point down speaks to a technology investment that we made. Really excited about it. It also went well, probably a larger scale effort than either of the bank acquisition integrations. And that went off satisfactorily, it was kind of a functionality investment that our clients want. Drives greater client satisfaction, and in 2016, provides a revenue lift opportunity we intend to take advantage of.

Bottom of bullet points there, talked to some performance ratios. That we feel like are strong and we look forward to improving them. On ROA above 1% at 1.07%, return on tangible common equity at 12.47% and efficiency ratio down 50 basis points from 2014, despite a really significant amount of one-time numbers that Mark is going to dig into here in a little bit.

So our fourth quarter is highlighted briefly on the bottom. Earnings-per-share of $0.37 that we think normalizes, as Mark will discuss, at $0.07 higher when you add in the one-time events that he is going to speak to in some detail. The first half of successful addition to your franchise by way of a legal closing of Ameriana Bank on the last day of the calendar year, as we planned for that company's integration about two months from now. And, as I mentioned earlier, when I think about the net income earnings per share of $0.37, that would be after recognizing $4.1 million of combined acquisition expenses that Mark will touch on.

The last highlight that kind of spreads across the fourth quarter and the entire year, and John Martin will spend time on it later, was just some really consistent improvement in our overall asset quality, both in our legacy portfolios and those companies whose loan portfolios have joined us. As we look forward, John might have some thoughts on how we're scanning the local economy, the state's economy here in Indiana as well as Ohio and Illinois, impacts that we might see down the road from items like energy. But overall, looking backwards asset quality improvement that have aid our income results.

So at this point I'm going to turn the call over to Mark.

Thanks, Mike. My comments will begin on slide 5.

Total assets, on line 8, increased in 2015, by $937 million, or 16.1%, following a 7.1% increase in 2014 and a 26.3% increase in 2013. On line 3, good organic loan growth of 4% in 2014 and 9% in 2015, was further improved by a healthy acquisition strategy. Our Cooper State Bank acquisition in April and our Ameriana Bank acquisition in December added $430 million, or 11% growth, in loans. So on a combined basis, as Mike mentioned total loans increased 20% this year.

Consistent with the last couple of years' guidance, we are anticipating organic loan growth in the mid- to high-single digits again in 2016. The allowance, on line 4, in total dollars has declined very modestly in 2014 and 2015. However, as a percentage of loans, the allowance has declined from 1.87% in 2013 to 1.63% in 2014, and now totals 1.33% of total loans. Most of the decline is due to the purchase loans that are embedded -- that have embedded credit marks that do not require an allowance that are included in the denominator of that calculation. So the best overall analysis of our loan-loss coverage will be presented by John a little later, on slide 21.

Goodwill and core deposit intangible increased $16 million in 2014, due to intangibles created in our Community Bank of Noblesville acquisition, while increasing by $41 million in 2015 due to our Cooper State Bank acquisition and Ameriana Bank acquisitions, which have been positively offset by a pick-up for reduction of intangibles of $8.5 million due to the sale of First Merchants Insurance Group in 2015. The composition of our $4.7 billion loan portfolio, on slide 6, continues to be reflective of a commercial bank and it continues to produce strong yields.

The portfolio yield for 2015 totaled 4.2%, compared to 4.58% in 2014. And the fourth-quarter loan yields were 4.32% compared to 4.46% in the fourth quarter of 2014. Fair market value accretion has helped to minimize loan-yield compression and is identified pretty clearly in the net-interest margin slides later in the presentation.

On slide 7, our $1.3 billion bond portfolio continues to perform well, producing higher-than-average yields with a moderately longer duration than our peer group. Our 3.97% yield is actually eight basis points better than a year ago, and continues to compare favorably to peer averages of approximately 2.56%. Our duration is just five months longer than the peer, and the average life is right at five years.

The net unrealized gain in the portfolio still totals $36 million, and maturities are manageable into the near future. 2016 maturities total $168 million, with a yield of 3.69%, 2017 maturities total $169 million with a yield of 3.30%, and 2018 maturities total $118 million -- sorry, $112 million with a yield of 3.68%. The strengths in our investment yield has helped maintain our net-interest margin in this low flat-rate environment, and the variable nature of our loan portfolio with $2.1 billion repricing daily allows us to take on a little more interest rate risk than our peer banks, and we feel the return is worth the risk. In an effort to protect tangible common equity in a rising-rate environment, 48% of the portfolio is categorized as held to maturity.

On slide 8, non-maturity deposits on line 1 represent 77% of total deposits, and grew by $247 million or 7.5% in 2014, and $573 million or 16.3% in 2015. Those do include our acquisitions. So of the increase, $54 million or 1.6% was organic in 2014, and a much stronger number $241 million or 6.8% was the result of organic growth in 2015.

Now if you look at the bottom of the slide, on line 9, our tangible book value per share increased by $1.03 or 7.5% following a 12.2% increase in 2014 and an 11.1% increase in 2013. While not detailed on this page, the tangible common book value per share increased by $1.03, and includes $1.72 increase from EPS offset by M&A dilution of $0.28 per share and $0.41 per share in dividend payments.

We announce our acquisitions and talk about our earn back, but I just wanted to give you some of the specifics related to those announcements. We modeled day one dilution of $0.24 per share for Cooper State Bank upon announcement, and $0.29 for Ameriana, and we expected a $0.16 per share pick-up or positive offset when we sold the insurance group and eliminated those intangibles. And so our target of -- if you combine those three, the $0.24 plus $0.29 minus $0.16 is $0.37 per share, and the actual result as of 12/31/2015 was $0.28 per share pick-up or better numbers by $0.09 compared to our original models. So pretty pleased with our ability to continue delivering on the commitments that we make in acquisitions.

As previously mentioned the mix of our deposits, on slide 9, continues to improve, and our total 2015 deposit expense was just 40 basis points. All regulatory capital ratios on slide 10 are above the OCC and the Federal Reserve's definition of well-capitalized, and are internal targets. Organic loan growth, the implementation of Basel III, a $5 million redemption of trust-preferred debt, the cash purchase of Cooper State Bank, and our stock purchase of Ameriana resulted in a decline of 40 basis points in our total risk-based capital numbers from 15.34% at year-end 2014 to 14.94% as of December 31, 2015.

During our strategic planning meetings in December of 2015, Management recommended a modification to First Merchants internal capital targets. After extensive peer analysis and stress testing, the Board approved a modest increase in our tangible common equity from 8% to 8.5%, and a more meaningful decrease in total risk-based capital targets from 14.5% to 13.5%. While Management doesn't have immediate plans to reduce hybrid equity, in the near term, really or the long term, we shouldn't be adding any additional hybrid capital as we grow the balance sheet.

The Corporation's net-interest income on a fully taxable equivalent basis, on slide 11, totaled $207 million, up from $195 million in 2014. Our acquisitions for 2014 and 2015 positively effect total net-interest income, so looking at margin is a great way to normalize performance. Our net-interest margin totaled 3.91% in 2014 and declined to 2.80% in 2015. And given the interest rate environment and the fact that Community Bank of Noblesville's net-interest margin and Cooper State Bank net-interest margins were in the low 3%'s, we feel great about our 3.80% net-interest margin for the full-year 2015.

Our 2016 plan calls for one December of 2015 rate increase equaling the Fed's actual decision, but does not include any additional increases in 2016. We are anticipating that our net-interest income will essentially mirror organic loan growth on a core basis, so we're expecting our net-interest income to grow at a very similar rate as our organic loan growth, in the mid- to high-single digits plus approximately an additional $15 million that will be the result of the addition of Ameriana Bank into our Company for a full 12 months in 2016.

Total non-interest income on slide 12, when normalized for lines 7, 8, and 9 declined by $2.6 million for the year. However lost revenue in the second, third, and fourth quarters from the sale of the insurance business created a $3.3 million negative variance for the year, and accounts for more than 100% of the decline, as various other categories improved modestly throughout 2015.

Non-interest expense, on slide 13, totaled $177.5 million for the year, up from the prior-year total of $168.5 million. Community Bank was included in the results for a full year in 2015, and Cooper State Bank was included for half a year, in addition to $9.8 million of one-time merger, integration, and system conversion expenses. When normalized for one-time expenses, our 2014 -- I'm sorry -- when normalized -- when normalizing our one-time expenses for 2014 and 2015, non-interest expenses increased by $3 million, or just under 2% for the year. We feel very good about our growth rate of expenses, considering all new investments in people and facilities related to our acquisition expansion in Indianapolis and the Columbus, Ohio MSA.

Of the one-time items on slide 14, Cooper, Community, FMIG and Ameriana are all M&A-related items. Specifically we included items like core processing expenses prior to conversion, where we are carrying their system cost on an ongoing basis, the severance and retention expenses of employees that do not stay with the Company post integration, contract termination expense related to the acquired Bank's technology or core system, physical infrastructure, and investment banker fees. Those are some of the items that we've highlighted as being one time or extraordinary.

And in the yellow item on this chart, labeled online banking and other, it includes our online banking conversion from S1 or ACI, that Mike mentioned, to FIS for both consumer and commercial online banking users, which consisted -- and the cost really consisted of some technology expense, but primarily all of the temporary human resource expenses related to adding about 80 additional call agents during the time of conversion to assist our customers and customer service during this significant access-channel enhancement. And additionally, highlighted in the yellow column are our Branch write-downs resulting from consolidation activities where -- which those are the largest item in the other category.

Now on slide 15, net income totaled $65.4 million, and EPS totaled 1.72% for the year. Higher net-interest income on line 1, reductions and provision expense on line 2, and improved operating leverage throughout, offset by an increase in taxes -- a one-time increase in taxes of $2 million related to the sale of the insurance agency produced an 8.6% increase in net income, on line 9, and a 4.2% reported EPS increase, on line 10, while continuing to improve our efficiency ratio for the last two years consecutively.

Now on slide 16, you'll notice our quarterly run rates from 2014 and 2015. And just as a reminder, the fourth quarter included $0.07 of one-time M&A expense related to Ameriana's closing on December 31 of 2015.

Thanks for your attention, and now John Martin will discuss our loan-portfolio composition and related asset quality trends.

All right. Thanks, Mark, and good afternoon, everyone. I'm going to be updating the trends in the loan portfolio, starting on slide 18, then review the asset-quality summary and reconciliation, go into the fair value and allowance coverage, and then close with a few thoughts on the portfolio.

So if you please turn to slide 18, I'm going to start in the first column. It's a fairly busy slide, of the change-linked quarter box, which represents organic loan-portfolio growth and which excludes the acquired Ameriana loans. So for the third-quarter total, on line 11, total loans grew organically by $52 million. The organic growth for the quarter was driven by increases in the commercial portfolio, where on line 1, commercial loans grew by $36.6 million, and on line 2, commercial real estate construction grew by $45.5 million.

Also of note, on line 8 was a $15.5 million increase in home equity lines driven by increases in new originations, while overall utilization declined modestly. Moving over a box, labeled change year over year, we organically grew $339 million -- call it $340 million, or roughly 9% for the year. The growth was in similar categories as the linked quarter, with C&I and CRE construction growing organically by $139 million and $130 million, respectively. Also on line 9, public finance grew year over year by $122 million. So all in all with Cooper, Ameriana, and the organic growth, total loans grew roughly 20% or $770 million.

Turning to asset quality on slide 19. Improvement in asset quality continues to be a good story, where year-over-year total NPAs and 90 days past due declined $32 million, or roughly 43% prior to the addition of Ameriana and Cooper State Bank. And $23.2 million or 31% with the NPAs and 90+ days delinquent loans from the merged companies. In this category, asset quality has improved both year -- both before and after the merged portfolios. Dropping down to lines 7 and 8, classified assets on line 7 were down 17% for the year, from $192 million to $159.8 million before adding $12 million in additional classified assets from Ameriana.

Then to see the quarterly change in the asset quality, let's turn to slide 20. This slide reconciles the migration of asset quality for the quarter year to date, and shows the effect of the inclusion of the Ameriana portfolio on asset quality. I've highlighted in the first quality -- the first column, rather, the year-end starting 2014 reference point, where ending NPAs and 90 days past due start at roughly $75 million.

Then, moving from left to right on line 14, you can see the study reduction in non-performing assets during the year declining to $53 million through the first three quarters of the year, and then, in the fourth quarter, down to $43 million, or roughly 43% year to date, before we added $8.6 million from Ameriana and ended the year at $52 million. So overall, a solid performance, saw some increase in OREO with the addition of the Ameriana portfolio, but through our own core portfolio had a solid overall improvement in asset quality.

Now, turning to slide 21, I'd like to turn your attention to the allowance and credit marks on our acquired portfolios. Highlighted in the far right column is the most recent quarter's allowance and fair-value position. The allowance, on line 1, has been mostly flat for the past year and has remained around $63 million for the year, finishing the quarter at $62.5 million.

Again, for the year, we had $1.9 million -- call it $2 million in net charge-offs, with $408,000 in the fourth quarter and no provision expense. With the continued improvement in asset quality, I would expect provision expense to closely follow net charge-offs in the near term with some marginal provision associated with portfolio growth. We're running at around 10 basis points or less of net charge-offs on an annualized basis, which would equate to roughly $1 million -- maybe a little bit more than $1 million a quarter provision barring recoveries or other events in either direction.

So dropping down to line 6, the allowance coverage to non-accrual loans improved and is being driven by the improvement in asset quality mentioned -- I just mentioned. That's increased from 193% to 199%, which continues to improve the coverage to recent historical highs. As a comparative measure, on line 7, the allowance to non-purchased loans -- these are just non-purchased loans, was 1.65% and, on line 9 the allowance plus the fair-value adjustment to loans and fair-value adjustment remained at 2.31%, with the addition of the -- call it $11.3 million of Ameriana credit marks. I think both of these numbers continue to highlight the relative strength or credit leverage remaining to cover charge-offs from both purchased and core portfolios.

So a couple of thoughts. Just quickly on slide 23 -- or 22 as I conclude my remarks. I feel good about the loan activity in the quarter across really, across the commercial spectrum, seeing good growth in the construction development and C&I portfolios. Asset-quality trends continue to improve, providing sound allowance coverage without really a current quarter provision, and we continue to have credit leverage with allowance and mark coverage exceeding 2.3%.

Thanks for your attention and I'll turn the call back over to Mike Rechin for his comments.

Thanks John. I'm on slide 24. A little overview of a couple items I'd like to hit on again if we hadn't covered them in either of my colleagues remarks.

The first word on the page is focus. Mark referenced, we start the year with a more narrow business scope, having exited the insurance business mid last year. So we're going to really concentrate on areas where we are particularly proficient in terms of extending credit across all the markets we cover, industries, verticals within commercial banking, and then gathering deposits from those same commercial borrowers and then through our in excess of 110 banking centers. Feel good about that straightforward approach. I think it's pretty consistent with where we are having our greatest success.

Referenced earlier, this third-quarter upgrade. We feel like between personal-fee use, commercial-fee use, we're going to have a lift in those combined categories in excess of $0.5 million. Largely comes from new clients, comes from a little bit from the acquisition, and it comes from pricing power for a better product that we're offering that, that customer mix.

The next bullet point down, organic growth. Our primary path to growing this Company is success in the marketplace and that calls for great execution on organic growth. It's difficult because it's an everyday deal, but between winning new clients, selling deeper into our clients, retail is working on this net-new accounts paradigm throughout our banking centers, which is proving successful as we try and make sure we're getting paid for accounts, and sometimes leaving legacy product offerings from retail concepts that have joined us a through these acquisitions. So we feel good about that.

Our Chief Banking Officer has a sales management protocol on all of our lines of business that gives me confidence that, if our markets have a reasonable economy to operate in, that we're going to get our share and more. Probably always looking at our talent level to make sure that in these new portions of our Company, we're getting people that grasp our value proposition in the marketplace and can adapt to the cadence that we expect to operate. It's kind of an everyday opportunity for us.

And then a couple of bullet points that are paired, this last one in the top section, proving our operating-performance progress, and then slightly down the page, continuing with some banking-center optimization and fuller implementation of some workflow technologies. Efficiency is the link between those two thoughts, and it's real for us. The efforts are real and the results are real.

Mark covered page 13 -- I'm sorry, 15. It had a three-year trend of efficiency from 62.5% to 61.3% to 60.8%, and the 60.8%, as he covered included several million dollars of a one-time expenses. So we would expect a fourth year of improvement with expected decline.

The top bullet point under the middle of the page, realizing acquisition synergies. It references Cooper State Bank in terms of a full assimilation but quite frankly we enter an important year three for our Lakeshore franchise, with growth kind of metric expectations, year two for Community Bank and Cooper's. You might recall Community and Cooper's pair with existing growth markets of ours. Community Bank as part of our Indianapolis business. Cooper State Bank as part of our central Ohio Region business. And so in year two, we feel like you begin to get to the run rate that gets us the kind of production on an overall market that we would expect.

We look forward to utilizing our integration techniques again here about eight weeks from now really, so the planning is well in place, and we look forward to it. I think our customers enjoy getting through the angst of change and seeing what our full-time branding, full-time service, same faces in many cases from those companies can provide.

And then the last point Mark kind of demonstrated when he went through some of the math on tangible book-value earn back, but we're trying to maintain a track record of delivering on several announced acquisition attributes. Some of them very financial, like earnings-per-share accretion or tangible book-value earn back. It goes towards items like getting the net-interest margin of an acquired institution closer to our core net-interest margin, which is tough. Typically comes from the liability side. More than anything it comes from things like talent retention and then getting the expense saves, which is really the dominant year-one activity, typically.

So we're going to open up the phone here, Jamie, for questions here in a moment. But draw some confidence from our ability to stay consistent in our 2015 performance. Look forward to the new year.

So Jamie, if there are folks with questions, we're prepared for them, I believe.

(Operator Instructions)

Scott Siefers, Sandler O'Neill & Partners.

Good afternoon, guys.

Hey, Scott. Good afternoon to you.

Thank you. Hey, Mark, first, a couple questions for you just on the expense side, and to start out sort of [tickey-tack]. So you gave the expense detail on slide 13. Just the major line items, I'm wondering if you can look at the $4.1 million in unusual charges from the fourth quarter, and just maybe let me know how they break out among the various expense categories?

And then the follow-on question on expenses is, if we break those out, you're at $42 million or so in total costs for the fourth quarter. I think Ameriana if I'm recalling correctly would add somewhere around $4.5 million or so per quarter, all else equal. So if we were to look at a $46 million, $47 million quarterly run rate, would that be a good number to go off of as the starting point before cost saves from Ameriana?

Well, let's see. I'm following up with a couple of different items to make sure I give you a good answer. The total -- let's see -- the $4.1 million. It looks like -- I apologize. Just a moment.

It looks like most everything related to the fourth quarter $4.1 million was really in the contract termination area. And then, and in the other -- well I should say split evenly. Looks like about half of it was severance and retention bonus -- severance and retention expense that we had, and then the other half were all contract write-downs.

So if you look at slide 13, it looks like a couple million dollars of that expense, about $1.8 million was in the salary and benefits, and then the rest was kind of split in the other outside -- no. Not outside data, I know it was all in item 9, other, to make up the $4.1 million. I apologize, I didn't spend as much time just on the quarter, but that's the breakdown of the $4.1 million.

Okay. No. That's perfect. And then, sorry to cut you off, but just the expense run rate when we get Ameriana in?

Yes. And Ameriana, their ongoing expense rate for us is -- it's going to be somewhere around $10 million for the full year of FY16. So we didn't have any expenses in 2016 with the exception of the one time. Nothing from a pure operating standpoint. And then, your question on the quarterly run rate. We are estimating that it is going to be somewhere between $45 million to $46 million per quarter, which I think is about what you mentioned.

Okay. Okay. Perfect. Thank you. And maybe just one follow up on the margin.

If you could maybe go into what, in your view, caused the core compression in the fourth quarter, and then if I understood your guidance correctly, it sounds like to reported margin should be pretty much stable with the fourth-quarter level going forward, such that virtually all NII growth is driven, then, from balance sheet expansion. Is that a correct way to think about it?

Yes. We might see a little bit of compression, but the way I describe that, I think having -- we'll pick up a little bit from Cooper that will help make up the net interest income difference, because we only had Cooper for about a half year in 2014.

And then when you just look at the fourth quarter, we had $233,000 less in fee income that went through the margin numbers. And we actually had $111,000 expense related to a refinance of one of our broker deposits. So for the quarter, we were about $340,000 less than normal in net interest margin that were related to fee income coming in a little weaker than the prior quarter. And that one-time extraordinary broker deposit refinance.

And then, the other item is we had about $85 million of additional earning assets that were all related to public money that, because we have a lot of public deposits when it's tax receipt time, the average earning assets increases by about -- in this quarter, increased by an average of $85 million, and those are deposits where we can only really invest them in Fed funds, and so it's an increase in earning assets but it really doesn't add anything to our net interest income.

So those two items combined are the reason the core margin looked low this quarter. But we should see a nice return in the first quarter, because we don't anticipate having the same weakness in the fee income, we won't have the broker deposits, and our earning assets should stabilize with a lesser amount of public money.

Okay. All right. That's perfect. Thank you for the color.

You're welcome.

Erik Zwick, Stephens.

Hi. Good afternoon, guys.

Hi, Erik. How are you?

Good, thanks. Maybe I'll start with regard to the mobile and online banking update. Which non-interest income categories present maybe the best opportunities for revenue improvement, and are you able to quantify that at all?

Yes, I tried to offer a little bit a moment ago. I'll go back over it, but they would be in our service charge category. Mark referred to fees just a moment ago, and the fees that he was relating to as a portion of net interest margin are actually commercial loan oriented fees that come back into margin should there be a prepayment ahead of maturity and accruing those fees.

Different than your question, where you're talking about our technology fees that come through service charges. So the largest individual line item within there has historically been overdraft charges, and it still is, but that general overall caption includes all of our business-related cash management fees as well as our personal fee income. And what I alluded to earlier was about a $1.3 million 2015 level for personal that we expect to grow about 15%, and on the commercial side, it's about 3 times that number in gross dollars just around -- just under $4 million.

That's also going to grow in our view about double digits, 10% or 11%. And when you dig deeper into it, a lot of it comes from existing customers taking advantage of better products for which -- are repriced on top of our normal in-the-market kind of gathering of new clients.

Great. Thank you for the color there, and then obviously within credit, the trends in non-accruals and early delinquencies are all positive. Is there anything that you're seeing that causes you concern with regard to future credit trends, either from a loan structure, economic, or kind of borrower health perspective?

Erik, when I think about what's happening in the world today, and there's been a lot of conversation around oil and gas and Ag and the Ag slowdown.

I look at our own portfolio and think we don't have a lot of direct exposure to those areas, and I think where we're potentially have some impact will be at a second-tier, third-tier, level as it works through the economy. In the manufacturing side, there is a lot of production in Indiana, northern Indiana and around the state that is impacted by slowdowns in those areas. We do have some exposure in the Ag production, the Ag land space, but nothing that is that, that significant.

So it's really more at the global economy level. We still continue to see strong construction activity in the multi-family space and senior space, and we continue to originate new opportunities there. But from an economic standpoint, that's kind of where I see things today.

Great. And moving onto mortgage, gain on mortgage sale revenue had a nice rebound in 2015. I guess any comments on your outlook for 2016, and how much maybe Ameriana could contribute?

Well, if you look at the way we ended the year, Erik, we had, to your point, strong fourth-quarter closing, about $68 million in closings. We actually take a pretty good-sized pipeline into 2016, and that would not reflect any of the Ameriana additions. They've been in the mortgage origination business, they were probably not as fully staffed in the origination function relative to their retail base, but given the overlap in our retail base, it's one of the synergies we expect.

So I think they had six folks in that business and $600,000 as a revenue line item, so we would clearly expect to bring that over, and then if we were to add our origination coverage on top of their physical franchise, there's some upside there. But we are early in it yet, to be honest. Until that integration takes place, Ameriana runs, while under our ownership, somewhat in this interim stage prior to rebranding and such.

Got it. That makes sense. And one more if I could. Just thinking about the size of the investment security portfolio relative to average earning assets. Are you comfortable with that level today, and would you expect it to grow commiserate with loan growth and the rest of the balance sheet?

We might be willing to see our loan to deposit -- or loan to asset ratio, I'm sorry, move up slightly, but this is right within our target range of where we'd like to see the bond portfolio. So it's been fairly steady for the last couple of years, and I wouldn't anticipate seeing that number grow in 2016. We are primarily focused on having our deposit funding increase the loan portfolio throughout the year.

Great. Thanks for taking my questions.

You're welcome, Erik. Thank you.

Damon DelMonte, KBW.

Hey. Good afternoon guys. How are you doing today?

Good, Damon. Yourself?

Great, thanks. My first question relates to the loan portfolio. Could you give a little color on some of the quarter-over-quarter declines, specifically with commercial real estate and residential mortgages?

Sure. The -- I think how I would address those is, as you come into the end of the year, we do have a portfolio -- a construction portfolio that is really designed to build, stabilize, and move to the secondary market. So there was some of that in the quarter, as well as just the loan amortization in the CRE portfolio.

So you've got that going on, and similarly in the residential mortgage space, you've got, again, normal amortization out of that portfolio that, without incremental originations into the portfolio -- again, a residential mortgage is really originate and sell, so we're not actively looking to grow that portfolio. Those would be the two primary drivers that I would point to in those portfolios.

Okay. The residential mortgage was down like $75 million or 11% on the quarter. It seems like that might be more than just normal amortization, although -- did you hold maybe more loans for sale last quarter or something? Or maybe you reclassified some loans and sold them this quarter?

I'm looking at my residential mortgage portfolio year over year, down $44.9 million. The linked quarter --

Down $12 million.

Down $12.1 million, and we acquired with Ameriana in the portfolio, linked quarter we were up $108 million. So I'm not sure --

I was looking at that slide 18, where it says Q3 2015, $677.8 million, and then the next column over it says $602.4 million. Isn't that the fourth quarter?

Back up. Slow down for me. One more time.

So slide 18.

Right.

The column heading Q3 2015, it shows residential mortgages $677.8 million, and then the next column over shows $602.4 million.

That excludes the Cooper State loans, which, if you will note -- look at the footnote, I apologize. The footnote at the top of that has -- we backed out the Cooper loans, just to show you the effect of Ameriana.

Okay. So the $677 million includes the Cooper?

Yes.

Okay. I got you. Okay. I thought they were both organic.

Yes, I can see where that would be confusing.

Then that totally answers my question, that makes sense now. Okay, thank you. I guess my next question, Mike, you mentioned in your final slide, there, about ongoing banking center optimization. Is there anything concrete with that? Do you have any plans to maybe trim some branches, or is that just part of the ongoing everyday philosophy of just trying to run the bank as efficiently as possible?

Well it is kind of ongoing, but it does get identified, if that's your question. Typically, when you're integrating the acquisitions, we move first to the easiest ones and try to take advantage of franchise change first. So while we have some legacy First Merchants banking centers that are struggling with the ability to grow based on transacting count being down, our pursuit of those efficiencies typically fall behind integration-oriented ones, with Ameriana upcoming in front of us, here.

I think we talked about 13 banking centers in Ameriana becoming 8, closing 8 actually, with 5 that will remain autonomous, the balance of them being combined into our stores. So that's kind of front and center for us, between now and May.

Okay. Perfect. And then just kind of broader picture here, with two deals completed during 2015. Obviously you have the conversion coming up for Ameriana. How does that change your approach to M&A in 2016?

Do you feel like you need to wait until you fully integrate Ameriana before you look for another potential opportunity, or do you feel that you are in a good enough place where if something came along in the next month or two, you could pursue that?

Well, yes. We feel if a great opportunity came up, we'd absolutely be ready to pursue it. Having the work, as you know, -- kind of in your question is embedded the idea that all of the work associated with an acquisition is not the same, whether you're on the front-end discovery stage, going through legal, working through integration. And so the ability for us to look at another opportunity between now and integration, which will come really quick, would take place.

I think of it much like the question to John about extending loans and trying to find a balance that's a fair opportunity, whether it's a commercial banking client, a retail banking client, or an acquisition where the value to us has to be strong and easy to see and negotiated at a fair price for both parties. But in terms of the core of your question, would we be ready to continue? The answer is yes.

Okay. That's all that I have for now. Thanks a lot. Appreciate it.

Thank you.

Thanks, Damon.

Brian Martin, FIG Partners.

Hey, guys.

Good afternoon, Brian.

Hey, Mike, just a follow-up to that last question, just on M&A. I mean, just given the conditions in the market lately, I mean, I guess, how would you gauge the temperature of the M&A market today? I mean obviously it sounds like you're ready, but I guess any apprehension on the part of sellers today? Are you seeing anything different than it was the last couple of months?

I'd say it's very consistent with the last couple of months. I think the number of institutions that we're having dialogue with is the same. Arguably, slightly higher. I think that the marketplace, the stock market valuations, give everybody reason to think things.

Getting to that fair, what's right for our shareholders value equation I think is critical. I mean we are at a fairly steady-state valuation there for a long time. It seems like we're at a temporary blip here. But I think that the number of Boards of Directors looking forward as to companies that they consider being a part of, I think that number is increasing.

Okay. And as far as -- go ahead, Mark.

I was just going to say we'll stick to our identical discipline, which is evaluating our cost saves, as you come up with the price based on the number of shares that you can afford to issue and the headline number based on recent changes in the stock price. It's a lower headline number, so we're continuing to work our way through opportunities and manage kind of different headline numbers. And I think that's the case throughout the M&A environment.

Okay. And does the size of the target you guys look at change, or I guess can you just remind me, I guess, what is the sweet spot, as far as where you would look?

Yes. I really think of Cooper as being an aberration. So Cooper State Bank at $130 million, at this point, would be an aberration for us to look at on a go-forward basis because of the effort that it takes. The real attraction to that bank was its absolute geographic overlap with our existing Columbus operation, and it's kind of unique delivery of traditional retail to our Ohio operation, which was exclusively commercial.

So 100 -- something less than $0.25 billion would be tough for us, and it wouldn't have an attraction to go to a new marketplace where we don't already operate for that size. So I think $0.5 billion is kind of a number that we think makes sense, where you can really dedicate all of your integration resources and produce income that benefits our shareholders.

Perfect. Okay. And then, maybe just one other question. Maybe, Mark, just on the margin, after the rate increase, I mean, any sense on -- I mean I assume no change from your commentary on the positive pricing pressure, anything you are seeing differently with a little bit of a bump in rates here?

We're not feeling like there's pressure on the deposit side at this point, and we have $2.1 billion that [we process] daily, so we have seen a nice lift in our prime base categories and our LIBOR-based categories with the December rate increase.

Okay. And Mike, sometimes you'll give some details on the commercial portfolio and just the pipeline, and where they stand just in general. I guess how do they look today versus -- would it be last quarter or however you guys track those?

Yes. I'll make -- I'll offer similar thoughts as I did a moment ago on mortgage. On the commercial side, we had a very strong fourth quarter of closings. A lot of it was actually late in the year, so while John was referring to some of the commercial real estate categories being paid off, that's our kind of normal expectation.

Our originations were strong. It actually produces a smaller pipeline on the first of this year, beneath $200 million, lower than $200 million, which is down a fair amount from the end of the third quarter. And those -- for that pipeline measure that I give often is for those opportunities where we have commitments that are in documentation, on their way to closing.

Right behind that would be opportunities where we think our ideas win with the client that haven't gone to being chosen yet. And there is ample opportunity in the market. That pipeline number is up $100 million over the third quarter. So while the immediate pipeline is lower than it was at the end of the third quarter, our combined look at activity is strong.

Got you. Okay.

And let me just add, then, to be more clear, I think we've been giving a pretty consistent 6% to 8% loan growth guidance for all throughout 2015. We wound up a little bit higher than that, at 9% organically. I like the 6% to 8% number. That net interest margin, we're trying to protect as much as possible. We could clearly increase our loan growth number if we wanted to compromise on the coupon on our commercial lending, and that's not a trade we really like. So I think I like the 6% to 8% number.

Okay. Perfect. That's helpful. Thanks, Mike, and maybe just the last one, and I'll step back and listen, is for John. Just two things, John, it looked like the organic classified number was up a little bit from third to fourth quarter. Maybe it was $5 million or $6 million. Just wondering if there's anything in there, and just what that was driving that.

And maybe I did the math wrong on this, but the non-performings look like, even with the addition of Ameriana in the quarter, they declined from third quarter to fourth quarter. Just what the improvement was? I think Ameriana maybe added $8 million or $9 million to the non-performing number, but just if you could give a little color on that, that would be perfect. Thanks.

Sure. Thanks, Brian. Yes. In the fourth quarter, as I mentioned, when I look at the Ag portfolio, we're looking at farmers that are coming out of the field that have had some deterioration. We're grading those appropriately.

And there is some effect of borrowers who are related to Ag and manufacturing by extension. And it is having an effect of driving that number on the criticized somewhat, but on slide 19, you look at 2015. It's down for classifieds, even in the fourth quarter, and then the criticized numbers -- it's really kind of flat to up a little bit, and it's just a part of the ongoing grading of the portfolio.

So I don't see it as a core trend, necessarily. I think when I think about the names that are in that bucket, there are names that are going to be in that bucket and come out of that bucket based on performance in a given couple of quarters. So I don't have a high degree of concern over that movement.

As it relates to the NPAs, I don't know if you wanted me to speak to those. I mean, we continue to move ORE. You look at that other real estate number at 11.6% for First Merchants by itself, that's down prior to adding the Ameriana. Really, it's the 5.8%, 5.7% is the Ameriana ORE, and we just continue to make good improvements.

Our 90 days plus delinquent is down, our non-accrual is down. And I don't really have it on this slide, but it's on the press release, we're making progress, as well, on the overall delinquency somewhat. So overall, the trends are positive, year over year and for the current quarter.

Got you. Okay. Thanks for taking the questions, guys.

You're welcome.

Justin Maurer, Lord, Abbett.

Afternoon, guys.

Good afternoon, Justin.

Just a quick question on Scott's question on the expense run rate. So is that coming out of the gates? Or I presume that is exiting 2016, just as Americana's cost saves roll in, or just trying to think of the timing of the redundant costs and as you convert in the couple months?

Mark, I can see, is looking for a report. So if you think about our fourth quarter of 2015, in the captions that Mark covered, it was the professional fees, investment banking and such. It was the looking-forward severance for those folks that won't be joining us permanently. It was the recognition in the fourth quarter of those folks at Ameriana whose talents we need through the integration. So all of that was last year.

So you think about the first quarter of this year, well, all we'll really have is the ongoing salary expense of those folks that will be leaving the Company post March. So we'll have one more quarter of a normalized salary level distinct from that severance amount, so you can read that as much lower than ongoing.

And then that will all kind of come to a close about the very first week of April, and so the second quarter, I made a comment in the press release you might have seen, Justin, that talks about looking forward to seeing our progress crystal clear in the second quarter, freed up of all of those M&A-related expenses. But I think at the heart of your question is -- should you expect a meaningfully lesser one-time number in the first quarter? And the answer is yes.

Okay. Well, I guess I'm a little confused, though. I'm looking at the slide where you lay out the one-time expenses for 2015, and you have $4 million for Ameriana. That was more contractual write-offs and such. Right? As opposed -- is that what you were saying earlier is half-half between that and the --

Fourth quarter of 2015?

Yes. Correct.

Yes.

So we're anticipating having higher level -- for all of 2016, first quarter will be our highest quarter.

Sure.

Because we're carrying more expenses for Ameriana prior to integration.

Okay, so --

Expense should be $47.5 million, somewhere in that range, and then it declines by almost $3 million there going into the second, third, and fourth quarters to get to the average that I was talking about.

I got it, yes. Okay, that was my question. So it starts at -- you said $47.5 million and then that's the peak and then down from there?

Yes.

Got it. Okay, and then just another one real quick. You laid out the tangible book dilution, I appreciate. So you said it's $0.09 better than you modeled, and since there was a lot of gnashing of teeth yesterday at one of your larger peers about a static method versus a crossover method of earn back of dilution, where does that get you guys, do you think, when you look at Cooper, Ameriana, and the insurance group?

So you are at $0.28, now that you're going to be on the positive side of the ledger, as you earn that back, what does that get you to, do you think, ultimately, in terms of the earn back?

Yes. I -- we think it moves the earn back close to a year shorter than what we were estimating. And those two transactions were kind of on the high end of three years to the low end of four years. So we definitely get a nice pickup right out of the gate. That is on just a pure static basis. Where would we be with that -- hopefully I'm using the term correctly, but on a static basis, where would we be on our own compared to where are we with the acquisition.

And that includes the earnings loss from the insurance business. Right?

It does. Yes.

Got it okay. Thanks, guys.

Thank you.

At this time, I'm showing no additional questions. I'd like to turn the conference call back over to management for any closing remarks.

Just an appreciation for folks, the quality of their questions and attention. Jamie, thank you for the call. I look forward to talking to everyone at the conclusion of our first quarter's call and results in a couple of months. Thank you.

Ladies and gentlemen, that does conclude today's conference. We do thank you for attending. You may now disconnect your telephone lines.