Earnings Call Transcript - FRME Q4 2021

Operator, Operator

Good day and welcome to the First Merchants Corporation Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. Good morning, or good afternoon, everyone, to our fourth quarter 2021 conference call. We released our earnings earlier today at approximately 8:00 AM Eastern Time. Hopefully, you have all found your way to our slide presentation. But if you haven't, you can access the slides by following the link on the second page of our earnings release.

Mark Hardwick, CEO

Thank you, Chris. And thanks for the introduction and for covering the forward-looking statements. On Page 3, you will see today's presenters and bios to include President, Mike Stewart; Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki. Page 4 is a one-page snapshot of the First Merchants' geographic footprint and a few relevant financial highlights for your review. Year-to-date, return on assets of 1.39%, return on tangible equity of 16.17%, and our Moody's investment grade Baseline Credit rating are reflective of our high performing and sustainable business model. Now if you turn to Slide 5. As my quote in the press release states, we delivered a record year on many fronts. We've reached record levels for loans, deposits, total assets, and we produced record net income by earning more than $200 million for the first time in First Merchants' history. EPS totaled a record $3.81 per share, while investing in the future of our business, both culturally and digitally at record levels.

Mike Stewart, President

Thank you, Mark, and good afternoon to all. As you look at the next two slides, I want to provide an update on a lot of business results and their contributions within the quarter. Since nothing's changed within our strategy and key lines of business, which is Page 6. I'd ask just to turn to Page 7, we can focus on the region and line of business highlights. The top of the page offers a breakdown of the core loan growth by our business units. During the fourth quarter, we grew our total loan portfolio by an annualized rate in excess of 13%, with each business group contributing to that growth. For the full year, we grew our loan balances at our expected mid-single-digit growth rate, up nearly 7%. The Private Wealth Consumer and Mortgage Groups all grew in the quarter at low-single-digit annualized percentages, and the First Merchants' consumer portfolio growth has steadily increased throughout the year from both in-branch and online originations.

Michele Kawiecki, CFO

Thanks, Mike. My comments will begin on Slide 8, covering fourth quarter results. We are pleased to report another quarter of strong balance sheet growth, which you can see on lines 1 through 5. The numbers are reflective of the exceptional core loan and deposit growth that Mike Stewart just covered, leading to double-digit earning asset growth and total asset growth. Total assets grew $392 million during the quarter or 10.4% on an annualized basis. You will see on line 17, that net income totaled $47.7 million, a decline of $5 million from the third quarter where the declines in PPP fee income and securities gains created a meaningful variance. Pre-tax, pre-provision earnings remain strong at $55.2 million, bringing pre-tax pre-provision return on assets to 1.44% and return on equity to 11.68%. Earnings per share on line 23 totaled $0.89 for the fourth quarter. This represented a decline on a linked quarter basis of $0.09, all of which was due to less PPP fee income, less securities gains, and Level One acquisition expenses. Therefore, core earnings for the quarter continued to be strong.

John Martin, Chief Credit Officer

Thanks, Michele, and good afternoon. My remarks start on Slide 18 where I'll highlight the loan portfolio, including segment growth and industry concentrations, then provide a loan growth bridge, including the PPP loan program and finish with a review of asset quality and the asset quality roll forward before turning the call back over to Mark. So then turning to Slide 18, the loan portfolio consists of a diversified commercially oriented portfolio with concentrations consistent with those segments of the economy found in our geographies. In the quarter, the loan portfolio grew $296 million, excluding $91 million of PPP forgiveness or 13.4%, and for the year, $566 million, excluding $560 million of loan forgiveness or 6.6%. I provided loan growth bridges for both the quarter and the year on the right side of the slide. The PPP program is winding down with $107 million of loans remaining. Of those, roughly $4 million were in active repayment at the end of the year, leaving roughly $103 million left to forgive or otherwise repay.

Mark Hardwick, CEO

Thanks, John. On Slide 21, it's a great highlight of our track record of performance, which I'm really proud of. We have a 10-year total return of nearly 400% versus the SNL Bank index of 192%. Our EPS combined annual growth rate is 27.3% for the past 10 years and 11.7% since 2012 after returning back to more normal numbers post-crisis. Our CAGR for tangible book value per share is 10.1% which, as you know, was calculated post dividends, post share repurchases, and post M&A activity, which we think is a really strong result. Slide 22 highlights our CAGR for asset growth including organic and M&A activity, which totals nearly 12% dating all the way back to 2000. Over the last 10 years, the combined annual growth rate is 14%. We're excited to close our Level One acquisition in the first half of 2022, and as Mike mentioned, we're growing increasingly optimistic about the opportunity that exists in the Detroit MSA.

Scott Siefers, Analyst

Good afternoon, everyone. Thank you for the question. Michele, my first question is for you. The underlying margin excluding PPP and purchase accounting benefits is just over 2.92%. What are your thoughts on where it might go from here?

Michele Kawiecki, CFO

We expect to see margin improvement in the next quarter from the funding cost savings mentioned earlier, aside from any Federal Reserve rate hikes. We're experiencing double-digit growth in commercial loans with stable yields. Although there is pressure on core margin this quarter due to excess liquidity, we are confident in our pricing discipline. We were somewhat surprised by the strong growth in our deposits, but since it was core, we are very pleased with it.

Terry McEvoy, Analyst

Hi, good afternoon, everyone.

Mike Stewart, President

Hi, Terry. It's Mike Stewart. I think we'll stay really confident with that mid to high single-digit loan growth, probably primarily driven through the Commercial segment. We're starting to see some pick-up like I noted on the consumer side as well. So that's where we're going to keep our plan.

Michele Kawiecki, CFO

Yeah. I would say, Terry, that we're probably expecting our quarterly run rate on fee income to be $27.5 million. We do expect a meaningful decline in mortgage gains in 2022, not so much because of production volume, but more because of just pricing. We think pricing was pretty healthy in 2021, and we think it will normalize this coming year.

Daniel Tamayo, Analyst

Good afternoon, everybody. Thanks for taking the call. Maybe if we could just touch on the thoughts on the operating expense base. We were at kind of in line with expectations in this quarter, just in terms of what you're thinking for the coming year given wage inflation pressures and anything else would be helpful.

Michele Kawiecki, CFO

Hey, Daniel. We think that our run rate next year will be around $73 million on average. Expense growth, we're expecting to be in the low to mid-single digits for new hires and digital infrastructure needs. So that's kind of what we're expecting.

Damon DelMonte, Analyst

Hey, good afternoon, everyone. Hope everybody is doing well today. First question, just regarding the outlook on credit. I mean things are obviously humming along pretty well for you guys. Can you give a little perspective on the provision going forward?

John Martin, Chief Credit Officer

Yeah. I can speak to the outlook on the credit itself. As you can see through the end of the year, it has been stable and improving. It's really been a positive story throughout 2021. As I look into 2022, I don't really see a material change from my review of the portfolio. In terms of the provision expense, given our coverage and where the allowance stands today, the plan is to grow into the allowance with minimal or no provision expense.

Mark Hardwick, CEO

Brian Martin, Analyst

Hey, good afternoon everyone. Thank you for taking the questions. Just wanted to just touch on the people you guys hired, the recruiting you guys were successful with this year.

Mark Hardwick, CEO

In 2021, we had about 20 sales folks. And as Mike mentioned, 11 of those were on the commercial side of the bank, the others were kind of scattered throughout our remaining lines of business. But we also had a meaningful increase of almost about the exact same amount in a combination of IT and the digital team that is helping drive the online account opening in the Force.com knowledge.

Operator, Operator

Thank you. And this concludes our question-and-answer session. I would now like to turn the conference back over to Mark Hardwick for any closing remarks.

Mark Hardwick, CEO

My only closing remarks are that I appreciate your interest and your attention to First Merchants. We have a number of stakeholders that are listening today from shareholders to employees and customers and our regulators, and we just appreciate the continued commitment to our performance. So until the next call, have a great first quarter of the year.