First Merchants Corp Q1 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to the First Merchants Corporation First Quarter 2023 Earnings. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. Before we begin, management would like to remind you that today's call contains forward-looking statements with respect to the future performance and financial condition of First Merchants Corporation that involve risks and uncertainties. Further information is contained within the press release, which we encourage you to review. Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. The press release available on the website contains financial and other quantitative information to be discussed today as well as reconciliation of GAAP to non-GAAP measures. I would now like to hand the conference over to your speaker today, Mark Hardwick, CEO. Please go ahead.

Good morning, and welcome to First Merchants first quarter 2023 conference call. Victor, thanks for the introduction and for covering the forward-looking statement on Page 2. We released our earnings today at approximately 8 a.m. Eastern Time. You can access today's slides by following the link on the second page of our earnings release. On Page 3 of the presentation, you'll see today's presenters and our bios to include President, Mike Stewart; Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki. On Page 4, you will see the geographic locations of our 121 banking centers that serve as the physical location where approximately 400,000 customers periodically stop in to visit a trusted First Merchants banker for advice and consultation. It's also where a little over 2,100 First Merchants employees work face-to-face with their colleagues to grow their careers, while attending to the financial needs of our customers and our communities. It's where the culture comes to life and why some of the awards at the bottom right of this page were received. Given the turbulence of the past quarter, I'm glad we have such a grassroots community banking model. Honestly, I love our business model, and I love being a community banker. And since we last talked, the environment has provided tremendous opportunities to have thoughtful and thorough conversations with our clients. Turning to Slide 5. I'm pleased to report that loans, deposits, on-hand liquidity, and capital are all higher, better, or stronger than at year-end 2022. We reported earnings per share of $1.07, an increase of 17.6% over the first quarter of 2022, and earnings per share total of $0.91 per share. Net income was nearly $64 million. Return on tangible common equity totaled 19.82% and return on assets totaled 1.42% for the quarter. Our balance sheet, including capital, is strong. Deposits and on-hand liquidity are higher than year-end. Loan growth continued for the quarter totaling 7.9% and loan yields continue to grow as well. Our efficiency ratio is at our target levels in the low 50s, and our credit quality remains healthy. No provision expense was recorded during the quarter. We continue our focus on delivering high-performance results to meet the needs of our stakeholders, including projects like our digital modernization efforts. We even signed new contracts with both Q2 and SS&C and are hard at work to deliver on our timelines for deployment. Now Mike Stewart will provide more insight on our balance sheet growth performance, and John will dive into the details. You're all looking forward to hearing regarding our liquidity and credit.

Yeah. Thank you, Mark, and good morning to all. The past two years, I haven't spent any time on Slide 6, and that's where I want to start, as our strategy has not changed. But considering the recent turmoil in the banking industry, it's worth reminding ourselves that our results represent the durability of our business model and the markets we serve. Visualize the map Mark reviewed on Slide 4, where we primarily operate within these three states. It's the heart of the Midwest. Our markets include growing metropolitan cities like Indianapolis, Columbus and Detroit, midsized cities like Fort Wayne, Ann Arbor, Lafayette, Muncie, and Munster, along with many small towns in between. As the last bullet point under the consumer banking header states, we serve diverse locations in stable rural and metro markets. It's a granular and diverse customer base with deposits from all banking segments: consumer, high net worth, small business, large corporate, government agency, and commercial real estate clients. For the first quarter of 2023, these markets have remained resilient in the face of the industry turmoil and an uncertain macroeconomic environment. Unemployment rates remain stable. The consumer remains healthy, and our business customers continue to seek ways to expand and optimize their operations. Our private clients continue to trust our advice and counsel. We remain committed to our business strategy and remain committed to our strategic direction of organic growth, investing in our team, investing in our digital products and platform and top-tier financial metrics. So let's turn to Page 7. The top of the page offers a breakdown of the core loan growth by our business units. We guided last quarter that we would expect loan growth to be in the mid-single digits and for the first quarter, loan growth was 7.9%. The Commercial segment growth was a blend of the commercial industrial and investment real estate sectors growing across all the markets we serve. As John Martin will further detail, our C&I business is granular with a stable credit profile, and our investment real estate focus is not on the office sector. I want to spend more time on the global loan results, specifically the dollar increases behind the percentages on this page. As noted on Slide 10, the Commercial segment represents 75% of our total loan portfolio. The 5.6% of first quarter growth is approximately $161 million or 68% of the total growth in the quarter of $238 million. While the consumer segment contracted this quarter by 4.1%, the dollar amount was less than $5 million. The mortgage portfolio growth during the quarter was approximately $80 million versus the prior quarter mortgage growth of $105 million. My point is the commercial segment continues to be the loan growth engine of the bank, and within the commercial portfolio, we are starting to get higher spreads. Within the Investment Real Estate segment, spreads are widening by 25 to 40 basis points on a similar risk profile from the second half of 2022. And in the C&I space, spreads are slowly widening by 25 basis points, with a strong emphasis on relationship strategies like deposits and fees. We have maintained a consistent and disciplined approach towards underwriting within all these segments. John Martin has more detail on the loan portfolio later. But know the commercial and consumer pipelines ended the quarter at consistent levels to prior quarters. The mortgage pipeline ended lower for the sixth consecutive quarter. Moreover, at the start of the year, we strategically adjusted our approach towards loan mix and are pivoting back to an originate and sell model with 70% of originations to be sold in the secondary market and 30% in the portfolio. Overall, the outlook affirms my expectation of single-digit loan growth moving forward to 2023. I now want to speak to the deposit section on the bottom half of the page. Deposit balances grew at nearly 9%. We have been in active dialogue with all of our clients discussing the safety of the deposits, the pricing options we provide and adding First Merchants context to the banking headlines. Our commercial deposit showed less than a 1% decline. While we onboarded new relationships through the quarter, our operating balances across the network declined, as higher-cost borrowings under line of credit were a better use or were repaid or were used for other strategic business investment opportunities. The average utilization rate of the commercial lines of credit and for consumer HELOC were flat to prior quarters. As I've discussed previously, our consumer digital deposit acquisition initiatives began well over a year ago. Over that time frame, we've demonstrated an ability to execute as a company as we launched our new online account origination platform, and we continue to grow our consumer deposit balances and households throughout the quarter and the online channel accounts for nearly 30% of the new account openings. We also launched our new brand campaign to support our customer acquisition strategy through radio, print, digital and in-branch advertising. The campaign demonstrates our interest in helping our customers and communities prosper and has supported the deposit growth we experienced in the Consumer segment, which was nearly 11% in the quarter. The acquisition strategies have been supported by continued retention strategies that our personnel deliver, deepening the relationship with our solution-based customer service, enhanced online, mobile and ATM features and convenience, along with our customer-friendly overdraft approach. All these efforts are positioning us to increase the number of customers we serve and drive positive and profitable deposit balance growth. So, Michele has more details to share about our balance sheet, the granularity of our deposit mix and our income statement. So I'll turn it to you, Michele.

Thanks, Mike. My comments will begin on slide eight. During the quarter, we had deposit growth of $321 million shown on line four, cash flows from the sales of securities of $213 million, which is reflected in investments on line three, coupled with runoff cash flow from the investment portfolio of $72 million, creating total liquidity of over $600 million during the quarter. The liquidity was used to fund the loan growth that Mike just discussed in his remarks, of $238 million shown on line two, paid down borrowings of $160 million and retained cash in excess of $200 million, which we chose to do as a matter of prudence, given the recent disruptions in the banking environment. Our loan-to-deposit ratio this quarter remained relatively stable and low at 83.3% compared to 83.5% in the prior quarter. Our earning asset mix continues to trend in a favorable direction, and we feel our balance sheet is well positioned heading into the second quarter to support growth. Pre-tax pre-provision earnings totaled $75.4 million this quarter. PTPP return on assets was 1.67% and PTPP return on equity was 14.48%. Interest-earning asset volumes and yields were up, but this was offset by a lower earning day count this quarter as well as higher deposit costs, resulting in net interest income of $144.1 million shown on line 11, a decline of $4.9 million from the prior quarter. Net income on line 17 totaled $64.1 million, and our efficiency ratio remained low at 51.72%, demonstrating excellent operating leverage. The tangible common equity ratio on line 6 increased 41 basis points, totaling 7.75% and tangible book value per share on line 26 increased $1.48 or 7% to $22.93, reflecting the strong earnings from the quarter as well as a meaningful recovery in the unrealized loss valuation of the available-for-sale securities portfolio. Slide 9 shows highlights of our investment portfolio. On the top right, you can see the yield on the portfolio remained relatively stable given we weren't reinvesting cash flows in bonds. The total portfolio balance declined approximately $200 million from last quarter due to $213 million in the sales of bonds, resulting in a modest realized loss of $1.68 million or 0.8%. Those sales, coupled with scheduled paydowns and maturities were offset by an improvement in the overall valuation of the portfolio of $51 million to arrive at the net decline of $200 million. On the bottom right, you can see we had a net unrealized loss on the mark-to-market of the available-for-sale securities portfolio of $245.7 million at quarter end compared to $296.7 million in Q4, which reflected a nice recovery. We also note the unrealized loss on the held-to-maturity portfolio of $328.8 million, which was also improved by $51 million. The effective duration of the portfolio was unchanged quarter-over-quarter, remaining at 6.4 years. The investment portfolio as a percentage of total assets is currently around 22%. This is down from a peak of 29% at the end of 2021, demonstrating the progress of a return to a more normalized earning asset mix. In the bottom left, you will see the cash flow we expect to receive in the remainder of 2023 of $220 million, which includes cash from principal and interest payments as well as maturities. We will also continue to sell bonds where we see opportunity creating additional cash flow. Since quarter end, we have sold approximately $69 million in bonds, taking a very minor loss of $300,000. So the bond portfolio will continue to be a strong source of liquidity to fund our loan growth through the year. Slide 10 contains highlights of our loan portfolio. In the bottom left corner, you will see the stated first quarter loan yield increased meaningfully, up 42 basis points to 6% from last quarter's yield of 5.8%. On the top right, I noted the yield on new and renewed loans, which also increased substantially from 6.1% last quarter to 7.08% this quarter, an increase of 98 basis points. We are pleased with the progress we have made in pricing and feel confident in our ability to maintain that discipline going forward. On the bottom right, you will see $8.2 billion of loans, or 67% of our portfolio, are variable rate with 38% of the portfolio re-pricing in one month and 51% repricing in three months. So we will see an increase in interest income from the loan portfolio, if the Fed increases rates another 25 basis points. Slide 11 shows the details related to our allowance for credit losses on loans. We did not record any provision expense during the first quarter and had net charge-offs of only $225,000, which brought the ending allowance for credit losses on loans to $223.1 million. The coverage ratio trend is shown in the graph on the top left. Our coverage ratio at the end of Q1 is 1.82% and down from 1.86% at the end of Q4 due to loan growth, which is ample compared to peer averages of 1.2%. This reserve, coupled with the remaining fair value accretion of $29 million, which gives us some additional coverage for acquired loans, provides great credit protection given the uncertainty of the economic environment. Now I will move to slide 12. We continue to have a strong core deposit base. Our noninterest-bearing deposits were 20% of total deposits at the end of the quarter, which is down from the peak of 23.6% in the second quarter of last year. This decline is the result of runoff of stimulus dollars, but more recent activity represents the mix shift felt across the industry as our new and existing clients move into higher-yielding deposit products. Due to the design of our checking accounts, we pay interest on those products, which might make our percentage of noninterest-bearing deposits appear lower compared to some other banks, but the interest we pay on a substantial number of those balances is very low. I noted in the highlights that 47% of our total deposit balances earn only 5 basis points or less. These balances declined 23.2% quarter-over-quarter. Our total cost of deposits increased 49 basis points to 1.41% this quarter, reflecting the competitive pricing environment. Our interest-bearing deposit cycle-to-date beta at quarter end was 37%, which was up from 29% last year. I disclosed the total deposit costs for March, which were 1.6%, demonstrating the ongoing upward pricing pressure we're experiencing. Slide 13 includes some additional disclosures we added this quarter about our deposit base and funding sources. Our deposit base remains very granular with the average deposit account totaling only $35,000 and having great diversification by commercial industry as is demonstrated in the top left graph where we have disclosed the top 10 next categories. FDIC insured deposits totaled 57.2% of total deposits; in addition, the State of Indiana has a public deposit insurance fund that ensures public deposits providing insurance to an additional 14.8% of our deposit base. Therefore, only 28.1% of deposits are uninsured, and we have ample liquidity to cover those deposits as is disclosed in the bottom right. Overall, we feel these disclosures illustrate the attractiveness of the granular, diverse deposit franchise we enjoy and our strong liquidity position. Slide 14 shows the trending of our net interest margin. Line 1 shows net interest income on a fully tax-equivalent basis of $150.4 million. When you back out non-core interest income items such as fair value accretion on Line 2, our core net interest income totals $148 million, which is shown on Line 4. This is an increase of $42.9 million over the first quarter of 2022 and a decline of just $4.5 million compared to the prior quarter. Stated net interest margin on Line 7 totals 3.58% for the quarter. Adjusting for fair value accretion brings us to core net interest margin of 3.52%, which is shown on Line 10, an increase of 55 basis points over the first quarter of 2022 and a decline of 13 basis points from last quarter's core NIM of 3.65%. The lower day count in the quarter caused a five basis point decline on a linked-quarter basis, leaving an operating decline of just 8 basis points. On slide 15, non-interest income came in as expected and totaled $25 million for the quarter, which increased $0.9 million on a linked quarter basis. Customer-related fees this quarter totaled $24.5 million, increasing $2.6 million from the prior quarter. The increase was driven by higher card payment fees as well as higher client interest rate loan level hedging activity, offsetting this customer-related income; we recognized a $1.6 million loss on the sale of $213 million of available-for-sale securities, as I mentioned earlier. Moving to slide 16. Total expenses for the quarter totaled $93.7 million. Salaries and benefits expense increased $5.1 million; $1.3 million of that increase was due to annual benefit plan expenses incurred in Q1 and the remainder was due to merit increases and incentives. FDIC assessment costs increased as a result of the two basis point increase but were offset by one-time FDIC credits of $2 million recorded in Q1, resulting in a quarter-over-quarter decrease of $900,000. We also experienced reduced marketing costs of $1.8 million over last quarter and other expenses increased significantly because we recorded $700,000 of gains on the sales of property in Q4, which didn't recur. Our low core efficiency ratio reflected in the top right shows that we continue to achieve strong operating leverage even while we invest in technology and talent to grow the business. Slide 17 shows our capital ratios. Our earnings growth this quarter drove capital expansion in all ratios. The comments and the highlights draw attention to the impact of investment security marks on capital ratios. You will see the tangible common equity ratio is 6.36%, including the held-to-maturity marks and the common equity Tier 1 ratio is 9.61% after incorporating the unrealized loss on available-for-sale securities reflected in accumulated other comprehensive income, reflecting great capital strength. It is important to note that all regulatory capital ratios remain well-capitalized after incorporating the available-for-sale and held-to-maturity investment marks. Overall, we are pleased with the balance sheet strength and resiliency of our business reflected in these Q1 results. That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John Martin, to discuss asset quality.

Thank you, Michele, and good morning. My remarks begin on Slide 18, where I discuss the loan portfolio, including growth and composition by segment. I will also comment on the expanded portfolio insights, review asset quality, and end with a look at non-performing assets. On Slide 18, we saw total loans increase by $161 million, with total commercial loans growing by the same amount. This growth was driven by increases in regional and middle market commercial and industrial (C&I) loans, along with stronger growth in C&I sponsor finance. This follows a strong fourth quarter in the regional and middle market C&I segments despite a decline in C&I sponsor finance balances. Moving to Slide 4, our construction loans grew by $125 million, and utilization rose from 61.8% to 63.2% from the previous quarter, up from 50.4% at the end of Q1 2022. The growth in construction was partially offset by approximately $30 million in pay-offs in investment commercial real estate. We maintain our underwriting standards as discussed in previous calls, which is leading to more equity in projects. Additionally, we are starting to see wider loan spreads. On line 9, the growth rate in the residential mortgage portfolio remained steady in the first quarter as we adjust rates to increase origination and selling levels moving forward. Before the rate changes in 2022, we had a sold-to-portfolio ratio of approximately 70% to 30%, but over the past year, this ratio has reversed to 30% sold and 70% portfolio. We are currently adjusting pricing on new pipelines to revert to historical levels. On Slide 19, I updated the portfolio insights slide, breaking down the portfolio in various ways to provide transparency. In the commercial sector, the C&I classification encompasses sponsor finance and owner-occupied commercial real estate linked to businesses. Our C&I portfolio reflects our markets, with a 19.1% concentration in manufacturing. Current line utilization remains steady at 41.6%, an increase from about 41% at year-end, while line commitments have risen by $126 million. We hold around $780 million in shared national credits across multiple industries, with an average balance of about $11 million, establishing relationships that provide access to management and revenue opportunities beyond credit exposure. We also have approximately $67 million in SBA guaranteed loans. In terms of sponsor finance, our borrowers consist of platform companies owned by private equity firms, with an expectation of sale. We review these relationships quarterly for any performance changes, including leverage, cash flow coverage, and borrower condition. I highlighted some key underwriting metrics such as cash flow leverage and fixed charge coverage. Classified loans improved, ending the quarter at 3.5%, down from 4.2% the previous quarter. In construction finance, we have limited exposure to residential development, focusing primarily on one to four family non-tracked individual build residential construction loans through our mortgage department. For commercial construction, we are biased toward multifamily construction. Looking at our consumer residential mortgage portfolio, it primarily includes prime originated residential and consumer loans, including HELOCs and HE loans, with some branch originated auto secured loans and other miscellaneous consumer loans. Overall, the portfolio represents a balanced mix typical of a Midwest bank. On Slide 20, I added further details about our non-owner-occupied commercial real estate portfolio, sorted by our level of exposure. Since the Great Recession, we've focused on multifamily commercial real estate lending while selectively adding other segments. Office exposure is detailed below the chart, making up 2.1% of total loans, with the highest concentration in medical rather than general office. Historically, this portfolio has performed well, similar to the rest of our holdings. Our office portfolio is diversified across tenant types and geographic areas. We regularly review our larger office exposures, which we believe are mitigated and acceptable under current market conditions. On Slide 21, as in previous quarters, I highlighted our asset quality trends and current status. We maintain our asset quality profile, with nonperforming loans at 50 basis points of total loans, an increase from 42 basis points in the prior quarter. We noted an uptick in loans that are 90 days past due, linked to two unrelated loans whose resolutions occurred post-quarter-end. The first was from settling a participation, raising the category by $4.5 million, and the second was due to renewing a $1.6 million loan, both of which have now been resolved. Moving to line 7, classified loans increased by $35 million to $250.5 million, or 2.04% of total loans, remaining comparable to pre-pandemic levels. We saw net charge-offs of $200,000 for the quarter, indicating another strong portfolio performance. On Slide 22, we once again show the migration of nonperforming loans, charge-offs, other real estate owned, and loans 90 days past due. Non-accrual loans increased by $4.3 million, stemming from new non-accruals totaling $15.4 million, reduced by payoffs or changes in accrual status amounting to $8.6 million, and a reduction of $1.4 million in loans moving to other real estate owned with gross charge-offs totaling $1.1 million. Additionally, there was a $5.3 million increase in loans 90 days past due, resulting from the earlier mentioned issues related to the $6.1 million in loans 90 days past due. Overall, 90-day non-performing assets along with those 90 days past due increased by $10.7 million, which still leaves us with favorable credit metrics. Despite challenges like labor shortages, material issues, and higher interest rates, borrowers continue to perform well. Mark, I will now hand the call back to you.

Thanks, John. Michele and Mike, I hope the level of detail provided demonstrates our desire to just create transparency into our business. I hope it's helpful to our current and our future investors. Slide 23 and 24 are provided just to share the highlights of our 10-year combined annual growth rates, and for both assets and total returns. And then if you look at slide 25, it's just a reminder of our vision, mission and our team statements, and the strategic imperatives that guide our decision making. I just thought I would point out given the environment we're in, that we're very much focused on maintaining top quartile financial results supported by industry-leading governance risk and compliance practices to ensure the long-term sustainability of the enterprise. So we really appreciate your attention, and we're happy to take questions at this time, Victor.

And our first question will come from Brian Martin from Janney. Your line is open.

Hey good morning, guys.

Good morning, Brian.

I appreciate the detailed information on the commercial real estate, construction, and various office portfolios. I have a question, John, regarding the classified loans you mentioned this quarter. Could you discuss any changes you've observed in the criticized loans, especially if you didn’t have that data previously? I'm trying to understand if there are any changes beneath what was presented in the press release. It appears that credit is performing quite well, so I just want to confirm that.

Yes, Brian. The criticized loans changed at a rate similar to the substandard loans. The migration within the portfolio was quite uniform. While the criticized loans indicate potential weaknesses and represent a larger dollar amount, their movement rate is comparable.

Okay. So pretty close. And then maybe just jumping to two other things. Regarding the expense, the increase this quarter was typical seasonal fluctuation. I’m wondering if Michele could provide any insight on what the base rate will be going forward. I know you mentioned the FDIC as a potential one-time event, but I'm looking for clarity on how to think about expenses in the future.

Yeah, sure. So I would look for our expense run rate to around about $95 million to $96 million on a quarterly basis through the rest of the year. We did have that one-time credit, but then we also offsetting that, we had some employee benefit expense that incurs in Q1, or I'm sorry, in Q1 each year, so that will not recur in the later quarters. And then there was also some incentive cost in there as well that's a little more seasonal. But so I would look for $95 million to $96 million as a normal run rate, Brian.

Got you. Okay. And then just maybe one other one, and I'll jump out and jump back in the queue. Just the margin, can you just talk about what was the margin in the month of March relative to what it was for the quarter? I'm just kind of trying to understand the baseline what we start at heading into 2Q here?

Sure. Give me one second here. So in March, our margin was 3.55%.

3.55%. Okay. Perfect. That's all I had for now. Let me step out, and I'll let someone else step in.

Okay. Thank you.

Thanks.

One moment for our next question. Our next question will come from the line of Damon DelMonte from KBW. Your line is open.

Hey, good morning. Hope everybody is doing well today, and thanks for taking my questions. I guess just to kind of continue on the margin discussion there, Michele. As you look at like your deposit betas over the upcoming quarters and if you kind of call the end of the cycle being at the end of this year, how do you kind of see that tracking based on where you are today?

We've analyzed various factors that influence our margin. After considering what might happen for the rest of the year, we anticipate our Q4 margin to be 3.43%, which is still 40 basis points higher than Q1 of 2022. We expect a potential decline of about 15 basis points for the remainder of the year.

Okay. That's helpful. Thank you. And then with respect to fee income, strong quarter this quarter, what are some of the puts and takes we should consider as we look at the remainder of the year?

I think this quarter's fee income level is a really good run rate for the remainder of the year. We do plan to sell more mortgage loans than we have in the last few quarters, and so we do think that could generate some gains. And so that's really kind of what is generating our confidence and stability.

Okay. Great. And then I guess, lastly, your approach to kind of dealing with the loan loss reserve has been to grow into it over the last couple of years here. Do you feel like you're getting to a point where you need to start providing for the growth that you're expecting, or do you think that there's still more room to grow into that?

I think there's more room to grow into it. We don't expect to have to take provision in the near term. We are modeling a mild recession in our models currently, but we'll continue to evaluate it each quarter with loan growth and particularly if we see any credit events that occurred during the year.

Okay. Great. That's all that I had. Thank you very much.

Thanks, Damon.

One moment for our next question. Our next question comes from the line of Scott Siefers from Piper Sandler. Your line is open.

Good morning, everyone. Thank you for taking the question. I was just curious, just given all the sort of the heightened visibility or, I guess, certainly on securities portfolios generally. Any thoughts on whether you guys would manage any of the securities portfolio even differently just given sort of all the unrealized loss issues both in AFS and held maturity as well?

I don't think there will be anything different in the way that we'll manage it. One of the things that I mentioned this quarter we were able to get $213 million in bond sales. In Q1, we've had $69 million in Q2. I think we'll continue to look for opportunities to try to harvest some of those bonds. And the loss that we've taken is pretty negligible. So we think that, that will continue through the remainder of the year, and that will provide some good liquidity for us, and we'll get back to a more normalized level of investments to assets.

I wanted to shift the conversation to the deposit base for a moment. Currently, non-interest-bearing deposits make up about 20% of your total. I also appreciated the insight into those lower-yielding operational accounts. In terms of the deposit mix, how do you anticipate the trajectory of your non-interest-bearing or low-yielding balances will evolve within the overall deposit portfolio for the remainder of this cycle?

I believe we will continue to experience some negative mix shift. If we focus on non-interest-bearing deposits, which currently represent 20% of total deposits, I expect that figure may decrease by another two percentage points by the end of the year.

Two percentage points or basis points?

2%, yes, sorry.

No problem. Okay. Perfect. That's good color. Thank you very much.

Thanks, Scott.

Our next question comes from the line of Ben Gerlinger from Hovde Group. Your line is open.

Hey, good morning, guys. It seems like you guys are still in a market share expansion, i.e., kind of in growth mode still. Have you seen any opportunities or any lending segments that people are stepping away from, or kind of more broadly speaking, are you seeing shots on goal now because of a bigger size and where pricing is kind of more in the bank shape is there less competition?

Well, it's Mike Stewart here. Yes, as our bank has grown, we have invested in a group of people that I would say focus on what we call upper middle market, the broader market might just call it in middle market, but we have the ability to work with larger companies, and therefore, control their entire operational accounts at the same time. And then our expansion into the Greater Detroit marketplace or Michigan, in particular, over the last year, gives us opportunity in that space as well. So, I do think that the organic growth in the commercial side in the middle market space is a good place for us to be, and that's where we're seeing most of our growth.

Got it. I have a two-part question. Regarding the deposits, they were solid. Was any of the growth due to seasonality factors that might lead to outflows, potentially boosting the first quarter results?

No, we don't really have much seasonality in our deposits. I mean, the only seasonality that we incur is intra-quarter with public funds where we see taxes come in. And that occurs typically in May and in November. But then by the time we get to the end of the reporting quarter, it kind of flows back out. And so when you look at quarter-end, there's really nothing there, I think, to know Ben.

I understand. Your deposit growth seems quite strong compared to the industry. I'm just thinking out loud, but it appears you might be experiencing some early positive influence on your beta. If loan growth doesn't occur, could it be that your margin is actually higher than what you projected for Q4, or is that idea too intertwined with various theories that align well with your Q4 forecast?

Yes, Ben, that's a valid observation. We became more proactive, as Mike Stewart noted, in early February and March with promotions focused on consumers and direct discussions with businesses. Under Michele's direction, we are confident about our overall margin and how it influences deposit betas. Given the current economic climate, adopting a cautious estimate seems appropriate considering the uncertainties. We are positive about our position and optimistic about the rest of the year and our growth potential. Funding is essential to that growth, so we certainly adjusted our approach in early February and took a more aggressive stance on deposit rates.

Got you. Appreciate the color and the extra insight on the slide deck. I appreciate it. I’ll step back. Thanks, guys.

Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Terry McEvoy from Stephens. Your line is open.

Hi. Good morning, everyone.

Good morning, Terry.

Maybe, Mark, I’ll start with a question for you, kind of a non-modeling question. When I look at slide 24, First Merchants has had kind of steady organic and bank acquisition growth over the years. So, I guess, my question is, if bank M&A is on hold for a while, how are you thinking about accelerating organic growth? Are there hiring plans you're contemplating? And any new markets that you think can provide some incremental growth? I think, a few calls ago you mentioned expanding into Cincinnati, if my memory is correct. But if you have any comments there, that would be helpful.

We remain confident in our guidance of mid to high single-digit organic growth over time. Given the current environment, we believe a lower estimate of around 5, 6, or 7 makes more sense for now. We are focused on M&A in deposit-rich institutions but don't expect to pursue anything until at least 2024. We aim to achieve similar results on a core basis during this period. Our interest in M&A stems from its potential to provide additional funding for loan growth and to introduce new markets for building a commercial bank, which usually leads to improved efficiencies and operating leverage over time. Our focus remains on the four states we currently operate in: Indiana, Ohio, Michigan, and potentially Illinois, though primarily the first three. At this stage, we are concentrating on strengthening relationships rather than discussing pricing for acquisitions. We have also signed agreements with Q2 and SS&C this year to enhance our online and mobile platforms along with our private wealth platform, and we are committed to completing these projects by the end of the second quarter next year. For now, our focus is entirely on internal projects, and I expect that to continue at least into 2024.

Thanks for that Mark. And maybe a follow-up for John. The Shared National Credit Portfolio, the 782, are there any leverage loans in there? And maybe give us a profile of what's in that portfolio in terms of who are the lead banks and some kind of concentration or geographic color would be helpful as well.

Yes, it fits into a category where the majority of the loans involve middle market companies that we collaborate with partners within our geographic area. This relates to my earlier statement about having access to management and cross-selling additional non-credit-related services to those companies. There is a small amount, around $100 million, of leverage loans rated BBB or better. These are mainly national companies, but they represent a minor portion. Some of these loans were acquired through the mergers we have completed.

Hey, Terry, it's Mike Stewart. The typical banks that we partner with would be the names like Huntington and Key and Fifth Third and banks that are leading transactions that are on our market. And we're partnering there because remember we also have a full syndication desk and capability. So it offsets what we're also selling to diversify portfolios on the other end, and those very banks also bind our transactions as well as selling downstream.

Perfect. Appreciate the color, guys, and Michele from you as well. Thank you.

Thank you, Terry.

Thank you. And that concludes our Q&A session for today. I would now like to turn the conference back to Mark for any closing remarks.

Yes. Just again, thanks for your interest and your investment in First Merchants. And again, I hope all the color we tried to provide helps you have great insight into our operating model. And hopefully, you can also tell from the comments that we're optimistic about the future of First Merchants and our performance. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.