First Merchants Corp Q4 FY2025 Earnings Call

Thank you for standing by, and welcome to the First Merchants Corporation Fourth Quarter 2025 Earnings Conference Call. 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 conditions of First Merchants Corporation and involves 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 and will be - as well as the reconciliation of GAAP and non-GAAP measures. As a reminder, today's call is being recorded. I would now like to hand the conference over to your speaker today, Mr. Mark Hardwick, CEO. Mr. Hardwick, you may begin.

Good morning, and welcome to First Merchants' Fourth Quarter 2025 Earnings Call. Thanks for the introduction and for covering the forward-looking statements. We released our earnings yesterday after the market closed; you can access today's slides by following the link on the third page of our earnings release. Joining me today are President, Mike Stewart; Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki. On Slide 4, you'll see our 111 banking centers across Indiana, Ohio and Michigan, along with several recent awards recognizing our culture and performance. We ended the year with record total assets of $19 billion, record total loans of $13.8 billion and record total deposits of $15.3 billion. On Slides 5 and 6, our strong balance sheet and earnings performance reflect the quality of the First Merchants team, our customer base and our community-oriented business model. For the full year, we delivered record net income of $224.1 million and record diluted earnings per share of $3.88, an increase of 13.8% from the previous year. Fourth quarter net income totaled $56.6 million or $0.99 per share. Annual return on assets was 1.21% and annual return on tangible common equity was 14.08%. Loan growth remained robust with $197 million of linked quarter growth or 5.8% annualized and nearly $1 billion or $939 million of growth for the year, representing 7.3%. Our efficiency ratio was 54.5% for the year, and we achieved significant operating leverage with revenues growing almost 5 times faster than expenses. We have now received all regulatory and shareholder approval to proceed with the acquisition of First Savings Group, which adds approximately $2.4 billion of assets and expands our presence into Southern Indiana and the Louisville MSA. We remain confident in our strategic and financial benefits of the merger, and we will actually close this weekend on February 1, 2026. Now Mike Stewart will cover some of our line of business metrics.

Thank you, Mark, and good morning to all. The business strategy summarized on Slide 7 has been updated to reflect the collective work of our lines of business leadership teams. Each of these business units refined and updated their strategy in alignment with our primary focus of building on our Midwestern strength, growing organically through deeper relationships and smarter use of technology for enhanced client relationship and internal efficiencies. 2025 was a year of momentum and record results. This slide summarizes how our teams have been winning and capturing market share. We remain a commercially focused organization across all these business segments with an eye on growing within the markets pictured on the next slide. So, let's go to Slide 8. As Mark stated earlier, this was another great quarter of loan growth across all segments and across all markets. It is very pleasing to see our Midwest economies continue to expand, our clients' businesses continue to grow and see our bankers continuing to win new relationships. $153 million in commercial loan growth for the quarter or 6% annualized, $852 million of increased commercial loan balances year-to-date, nearly 7% growth rate for all 2025. CapEx financing, increased usage of revolvers, M&A financing and new business conversion are the drivers of this growth. Another encouraging bullet point on this page is the quarter ending pipeline, which is stable from the prior quarter and gives me optimism that we will be able to maintain our loan growth into the first quarter. The Consumer segment also shared in balance sheet growth with the residential mortgage, HELOC and private banking relationships driving the $44 million of loan growth for the quarter and the $87 million for all 2025. Pipelines in this segment also consistent from our end of quarter prior. So we can turn to Slide 9 and talk about deposits. The fourth quarter was our strongest quarter of deposit growth with the consumer segment driving increases in new households and balances. Enhanced digital platforms are deepening our client relationships. Our marketing efforts are leveraging the strength of our local brand and the reputation that we have, and driving new relationships. The bottom section of this page summarizes the fourth quarter growth of $155 million of total consumer deposit increases with over $250 million in non-maturity balance growth. The full year's results also reflect the growth in the mix of non-maturity and maturity balances assisting in the margin improvement Michele will review next. Commercial business segment is summarized on the top of the page. While deposits have increased in both the quarter and year-to-date, the primary driver has come through our public fund depository relationships. It is a higher cost of deposit, but they are local government and public relationships that utilize many other treasury services we offer. Part of the increase in loan balances comes from higher line of credit utilization, which typically reduces operating deposit account balances. Improving the mix of all deposit categories has been the focus of our teams for the past year and has been accomplished by focusing on primary core accounts and deposit cost. Overall, I'm pleased with the active engagement our teams are having with their clients as we've continued our pricing discipline, specifically with maturity deposits and public funds and remain hyper-focused on relationships and converting single product users. Before turning the call over to Michele, one last comment regarding First Savings Bank. As Mark said, our integration efforts are on track. The engagement of their team has been strong. We have completed our product and process mapping. So post legal close, we will begin the on-site training and preparation for the May integration. Their community bank model and specialty verticals have a solid reputation and continuing their growth within Southern Indiana in these verticals will be our priority. So I'm going to turn the call over to Michele now, and she can review in more detail the drivers of our balance sheet and income statement.

Thanks, Mike, and good morning, everyone. Slide 10 covers our fourth quarter performance, which reflects a continuation of positive financial trends we had throughout 2025. Total revenues in Q4 were strong with meaningful growth in both net interest income of $5.4 million and noninterest income of $0.6 million. This resulted in overall pretax pre-provision earnings of $72.4 million, up $1.9 million from the prior quarter. Strong earnings drove a 4% increase in tangible book value per share on a linked-quarter basis. Turning to annual results on Slide 11. We delivered record diluted EPS and achieved an all-time high tangible book value per share in 2025. Year-over-year positive trends include double-digit net income growth of 12.2% and positive operating leverage. Tangible book value per share ended the year at $30.18, which is an increase of $3.40 or 12.7% from the prior year. Slide 12 shows details of our investment portfolio. On the bottom right, you will see the valuation of the portfolio improved meaningfully during the quarter due to changes in interest rates. The unrealized loss on the available-for-sale portfolio declined $30 million or 15%. Expected cash flows from scheduled principal and interest payments and bond maturities over the next 12 months totaled $282 million with a roll-off yield of approximately 2.09%. We plan to continue to use this cash flow to fund higher-yielding loan growth in the near term. Slide 13 covers our loan portfolio. The total loan portfolio yield declined by 8 basis points from the prior quarter to 6.32% due to the impact of recent Fed rate cuts. This quarter, new and renewed loans were originated with a yield of 6.51%, which remains a tailwind for the overall portfolio yield. The allowance for credit losses is shown on Slide 14. This quarter, we had net charge-offs of $6 million and recorded a $7.2 million provision. The reserve at quarter end was $195.6 million and the coverage ratio of 1.42% remained robust. In addition to the ACL, we have $13.4 million of remaining fair value marks on acquired loans, providing additional coverage for potential losses. Slide 15 shows details of our deposit portfolio. The rate paid on deposits declined meaningfully by 12 basis points to 2.32% this quarter. Our team strategically reduced deposit rates following the Fed's rate cuts, resulting in a $3 million reduction in interest expense even as deposits grew $424.9 million or 11.4% annualized in the fourth quarter. On Slide 16, net interest income on a fully tax equivalent basis of $145.3 million increased $5.4 million linked quarter and was up $5.1 million from the same period in the prior year. Net interest income was positively impacted by a $3.3 million recovery from a successful resolution of a nonaccrual loan. Our quarterly net interest margin of 3.29% increased 5 basis points from the prior quarter. Our teams continue to stay focused on growing loans and deposits using disciplined pricing, and our net interest income growth trend throughout 2025 is evidence of their success. Next, Slide 17 shows the details of noninterest income, which totaled $33.1 million with customer-related fees of $30 million. Customer-related fees were strong in all categories with notable quarter-over-quarter growth in wealth management fees of approximately $300,000, card payment fees of $300,000 and gains on sales of mortgage loans of $400,000. Moving to Slide 18. Noninterest expense for the quarter totaled $99.5 million, an increase of $3 million or 3% linked quarter. Expenses for the quarter included $500,000 of acquisition costs, which were offset by a reduction of the FDIC special assessment accrual of $700,000. Full year noninterest expense increased only $3.2 million or less than 1%, demonstrating significant operating leverage. Slide 19 shows our capital ratios. The tangible common equity ratio benefited from strong earnings and AOCI recapture, increasing 20 basis points to 9.38% while returning capital to shareholders through share repurchases and dividends. During the quarter, we repurchased 272,000 shares for $10.4 million, bringing total share repurchases in 2025 to just over 1.2 million shares for $46.9 million. We remain well capitalized with a common equity Tier 1 ratio at 11.7% and are well positioned to support continued balance sheet growth. That concludes my remarks, and I will now turn it over to Chief Credit Officer, John Martin, to discuss asset quality.

Thanks, Michele, and good morning. My remarks begin on Slide 20. We had strong loan growth for both the year and the quarter of 7.3% and 5.8%, respectively, led by C&I loans shown on line 4, which grew nearly $700 million for the year. While we experienced strong C&I loan demand, we saw more moderate growth in investment real estate for the year and quarter on Line 7 as higher rates slow demand and assets moved into the permanent financing market. The diversity of lending types our teams continue to originate has allowed us to grow as demand varies across various asset classes. On Slide 21 and Slide 22, we again provided more detail of the loan portfolio. On Slide 21, the C&I classification includes sponsor finance as well as owner-occupied CRE. Current line utilization leveled off during the quarter, declining slightly from 50% to 49.8% after climbing in the first half of 2025. In the sponsor finance portfolio, we track key credit metrics across 90 platform companies. We took a $4.4 million charge in the quarter to an individual borrower. We underwrite to higher origination standards compared to traditional C&I loans and track the portfolio quarterly. The portfolio almost exclusively consists of single bank credits for private equity-backed platform companies as opposed to large, widely syndicated leveraged loans from money center banks trading desks. On Slide 22, we break out the investment or nonowner-occupied commercial real estate portfolio. Our office loans are detailed on the bottom half of the slide, representing only 1.9% of total loans and any potential issues are easily managed. The wheel chart on the bottom right details the office portfolio maturities, loans maturing in less than a year represent 28.1% of the portfolio or roughly $73 million. On Slide 23, I highlight this quarter's asset quality trends and position. Asset quality remains strong. NPAs and 90-day past due loans on line 4 were up $5.6 million or 2.54%. The largest nonaccrual, a $12.9 million investment real estate multifamily construction project paid off without loss of principal shortly after quarter end. Adjusting for this payoff, NPAs and 90-day past due loans would have fallen to 0.45%, down year-over-year from 0.66%. Turning to the asset quality migration roll forward on Slide 24 in column 4Q '25, there were new nonaccruals of $22.8 million on Line 2, the largest of which was a $9.6 million investment real estate multifamily construction project. We had a $9.1 million reduction on Line 3 from payoffs or changes in accrual status primarily related to a nursing facility that had been one of the prior quarter's largest nonaccruals that paid off. During dropping down to Line 5, there were $7.3 million in gross charge-offs, the largest of which was the $4.4 million sponsor finance C&I borrower I mentioned earlier. Then dropping down to Lines 12 and 13, we ended the quarter up $5.6 million, excluding the early quarter payoff with NPAs and 90-day past due loans totaling $74.5 million. To summarize, asset quality remains stable and improving. Classified loan balances are largely unchanged at 2.56% of loans with 18 basis points of annualized net charge-offs. We continue to grow C&I loans with our commercially oriented teams. And finally, we are excited about the local opportunities and new business verticals First Savings Bank brings as we head into 2026. I appreciate your attention, and I'll turn the call back over to Mark Hardwick.

Thanks, John. Slides 25 and 26 have been updated, along with our 10-year combined aggregate growth rates. As we look forward to '26, we're committed to supporting our world-class teammates and serving the needs of our clients, which will deliver the high-quality results our shareholders have come to expect. We appreciate your interest and your investment in First Merchants. And at this point, we're happy to take questions. Thank you.

Our first question is from Brendan Nosal with Hovde Group.

Maybe just starting off here on the topic of kind of balance sheet optimization. If I recall correctly, last quarter, I think you said you were looking at how you could optimize the sheet short of a wholesale kind of raise restructure transaction. So can you just update us on what areas of the balance sheet you're looking at, what you would try to achieve with those actions and what the parameters are around the existing capital base?

Yes. Thank you, Brendan. Our line was disconnected just before the call began, so we've experienced another drop. Please give us a moment to reconnect. We are still considering the potential for some balance sheet repositioning. However, with the recent decrease in rates, the size of any action we might take is diminishing, reinforcing our previous communication that we do not need to raise capital. Any steps we take will be quite modest. We have decided to sell our entire First Savings bond portfolio, which is approximately $250 million at close. Additionally, we are assessing a small part of our bond portfolio and some of our lowest-yielding bonds and loans. If we proceed with anything beyond the First Savings bond book, it will be relatively small.

Our next question will come from the line of Daniel Tamayo with Raymond James.

Yes, maybe starting on the loan growth side. It sounds like pipelines are pretty consistent from where they were last quarter. Loan growth was certainly a solid good story in 2025. Maybe you can give us a sense for your expectations for overall loan growth and where those categories that might be driving that loan growth in 2026 are?

Yes, this is Mike Stewart. I'll try to take that. You're right. The pipelines remain consistent across the board when I think about geography or when I think about our segments. Our C&I teams focused on different size companies are all in a good position engaged along the way; our investment real estate team. The new asset-based team that we talked about a couple of quarters ago has been off and running and producing fantastic results. In this marketplace, that's a really good discipline to have as it rounds out a lot of things we're doing. So when I look at that loan growth, I feel like it's balanced through our segments and how we manage that and through the geographies as well. We might have even referenced about a year ago; we put some additional focus on our small business lending efforts through our consumer network. That also, while not a large dollar amount, has got good momentum across the board. I will say that's part of the strong fourth quarter; we had a couple of payoffs that didn't happen. So it ended our year a little stronger than I would have thought. So the first quarter, though, when I think about outlook, I still feel it's going to be in that mid-single-digit level. The economy is good in the Midwest, and our teams, I feel like, we can convert what we're doing.

Okay. So, you said mid-single digit for the first year. I apologize if I missed it. Did you think that will carry through for the year as well?

That's the way I'm looking at it, sure, yes.

Yes. I mean we're kind of mid- to high expectations for the year when you think about 6%, 7%, 8% is more how we think about the plan and consistent with what we delivered this year.

And I think about the opportunities that can come our way when we're partnering with First Savings Bank. It's a new part of the state, so we get to work in new areas with their team. And then they've got those verticals that we can continue to evaluate how we want to originate and sell portfolios or continue to utilize our balance sheet. So we've got some nice levers.

Our next question will come from the line of Damon DelMonte with KBW.

Just had a question on expenses and kind of the outlook there. Michele, could you give us a little guidance on kind of how you're thinking about kind of a core expense base for First Merchants given some of the moving parts in the fourth quarter? And then how we should kind of think about the first partial quarter with FSFG coming on board?

On a core basis, looking at year-over-year noninterest expense, we anticipate an increase of approximately 3% to 5% due to the reasons Mark mentioned, including the addition of talent. Additionally, we will be incorporating First Savings, whose operating expenses will begin after we close on February 1, leading to 11 months of operating expense. It's important to note that we expect to achieve annualized cost savings of 27.5% once we complete the integration, which is scheduled for May. Therefore, we believe we will be able to realize these cost savings more in the latter half of 2026.

Yes. And I wanted to just add when I talk about some of the additions of talent, just a reminder that back in '23 when we completed or announced a voluntary early retirement. At that time, we had about 2,145 employees. And today, we're about 2,035. That 5% reduction, we've been able to hold on to even with the addition of talent, and on a core basis, expect to add less than 2% to the FTE base and just excited about the quality of talent that we're bringing on to the company.

Got it. Okay. Good color there. And then with respect to the margin, Michele, did you say that there was a benefit of $3.6 million from interest recoveries on nonaccruals?

There was, yes. And when I look at core margin, go ahead, sorry, Damon.

Oh, no. Yes, I was going to dovetail that into the core margin, so go ahead.

Yes. Just looking at year-over-year, we built one rate cut in our plan that we had built in early in the year. And so on a core margin basis, we did expect that margin in 2026 would compress a few basis points. We do think that we'll be able to get some momentum on repricing deposits, which will help offset some of the asset repricing that occurs because of the commercial nature of our loan portfolio. But on a net interest income basis, we definitely expect to see growth year-over-year.

Our next question comes from the line of Nathan Race with Piper Sandler.

Maybe on fee income, nice growth quarter-over-quarter in 4Q. I'm just curious how you're thinking about the opportunities to grow some of the fee lines in 2026, just given the momentum in the fourth quarter and some of the ongoing areas that you guys are trying to grow? I think in the past, Michele, maybe we were talking in mid- to high single-digit range, but just curious if that's still a good expectation versus kind of the 4Q level?

On the noninterest income basis for 2026, I mean, we feel like we can get double-digit growth there. And so we're planning 10% growth. And some of that comes from some of the investment people that we have. We think we'll have some great momentum both in our wealth management space as well as our treasury management. Mike, I don't know if you want to add some color?

Treasury management and the investments we're making with our derivative product group will complement what we've achieved on the consumer side. The fee income should continue to grow, although it won't reach double digits, but it will contribute to the overall total. Moreover, once we move beyond our integration phase, the fee income opportunities from our acquisition will further enhance our mortgage business as we originate and sell their products and services, which will add value.

Yes, definitely. And just to clarify that double-digit growth expectation for this year, is that inclusive or not including FSFG?

We think we'll have double-digit growth even on a stand-alone basis.

Okay. Great. Good stuff. And then maybe a question for Mike. There's obviously been some notable M&A announcements with some of your larger Midwest competitors recently. So just curious if you're starting to see maybe some M&A-related disruption permeate through the loan pipeline these days? And maybe just any expectations in terms of how some of those competitors maybe more focusing on the South can impact both opportunities to add talent on the commercial side of things and then anywhere else across the company?

Yes, specifically, I’m addressing our Michigan market where we see an opportunity with Fifth Third and Comerica. Regarding the pipeline, we are already having initial discussions with clients through our teams, as well as potentially with other outside banks. Some clients may be hesitant to switch banks due to past experiences or the need to have alternative plans in place. So, these conversations are encouraging. I believe there’s an opportunity to strengthen our teams, although that may come later. Our team has done well to manage relationships and provide support. As for any disruptions and changes that might occur internally, we are well-prepared because we identify the right talent to enhance our team, and we are engaging in those discussions. From a consumer perspective, we are still considering how we can expand our banking center presence, and we are assessing that with Michele. Overall, there are certainly opportunities ahead.

Got it. That's really helpful. And then maybe one last one for Mark on buybacks. Obviously, stepped up in the quarter. And I think the valuation is still quite compelling with where you guys trade relative to peers. So just curious if we can expect the pace of buybacks to step up in 2026? Or do you think what we saw in 2025 is a good approximation for this year?

Yes. If we continue to trade kind of below average, I guess - I mean, it's an opportunity that we'd like to take advantage of, and we have the capital base to do it. So I don't have any desire really to see our TCE grow above the current levels. When we close the transaction, we'll see a decrease from that kind of 9.40% level, more like 8.70%, 8.80%, but still well above our target of 8%. We intend to be aggressive with buybacks as long as the price holds where it is. I'd prefer the price to be up when we didn't take advantage of it, but if this is where we are, it's the right thing to do.

Our next question comes from the line of Brian Martin with Janney Montgomery Scott LLC.

Maybe, Michele, just back to margin for just a minute. The core margin in the quarter ex that one-time item, kind of what was that? And then just remind us of kind of the normal seasonality that you'd expect in 1Q, I guess, as we think about it, I guess, kind of absent FSFG.

Well, core margin for the quarter, the interest recovery did add several basis points to our core margin of probably about 8 basis points. To your question about what we would expect in Q1 - because of the commercial orientation of our loan portfolio, the day count in Q1 always has a pretty significant impact. I think last year, it ended up being about 5 basis points. So when you look at the trend of margin, the seasonality definitely takes a dip in Q1 and then obviously rebounds in later quarters. But overall, for the year, we would just - the overall annualized margin, we would expect just a couple of basis points of compression, assuming that we get a Fed rate cut in 2026.

Okay. And just remind us kind of the impact of FSFG on the margin overall?

Yes. Once we pull the deal in, particularly because of the impact of some of the interest accretion, you will see that gives our margin some lift.

Our next question comes from the line of Terence McEvoy with Stephens Inc.

Maybe a question for John. Regarding multifamily construction, there was a mention of NPL formation and then the payoff. My question is, what are you observing across that portfolio of over $400 million? Additionally, based on your current outlook, do you expect charge-offs to be around $6 million to $7 million as seen in the third and fourth quarters? Are you comfortable with that run rate in the near term?

Yes, so when I think about the multifamily portfolio, it's generally in pretty decent shape. We have had a couple of names that as a result of the higher interest rates and quite frankly, just disagreement amongst partners and the strategy there that have kind of fallen out. The two names that one that went in, one that came out were examples of it. But it's not some wholesale problem. For the most part, we've seen those assets stabilize and move into the permanent market. When I think about charge-offs, I think about it in that 15 to 20 basis points about depending on what we have in any individual quarter. So yes, that $6 million to $7 million is probably about the right number.

Great. And then maybe a follow-up. Mike, you kind of ran through the positive consumer deposit trends and Michele talked about the success lowering rates. When I look at the decline in commercial deposits ex-public funds, is that a good sign for loan demand or commercial loan demand in 2026? Or is that just seasonality and I'm reading too much into it?

Well, there is definitely a correlation with line of credit usage and businesses using their cash to fund and finance. So there could be seasonality in it. That seasonality usually comes more from the public fund side when tax receipts grow and tax payments go out, and you see that in the second and fourth quarters. But when I think about the business flow and the core operating accounts, we penetrate relationships really well. I do think it's part of the working capital cycle. So when we do see revolver increases, I mean, John had a slide that showed them pretty flat, but my comments also talked about the draws that are happening under construction real estate, which also means they're using their cash into projects. So I do think it's a correlation to loan growth with where they're utilizing their excess funds.

We have a follow-up question from the line of Brian Martin with Janney Montgomery Scott.

Just one follow-up, I forgot to ask about the outlook for this year, considering the valuation and the current stock status in the buyback. How does M&A fit into that? It seems like you have a lot on your plate with the transaction ahead. Given the valuation, does it seem that the buyback is a more effective use of capital right now compared to M&A, and is that the perspective for the near term? How is the conversation around M&A at the moment?

No, I think you summed it up well. We're focused on the acquisition in front of us. And we do think that using our capital to continue to repurchase shares at the current price level is the best short-term strategy for sure. So we're really not spending much time thinking about what's next on the M&A front.

Thank you. This concludes today's Q&A session. This also concludes today's conference call. Thank you for participating. Everybody, have a great day. You may now disconnect.