First Merchants (FRMEP) Q3 2026 earnings call transcript

Good morning, and welcome to First Merchants's third quarter, 2026 conference call. Thanks for the introduction and covering the forward-looking statement on page two. We released our earnings yesterday after markets closed, and today's presentation materials are available via the link on page three of the earnings release.

Turning to slide three, you will see today's presenters and members of the executive management team. Joining me on today's call are Mike Stewart, our president, John Martin, our chief credit officer, and Michelle Kavieski, our chief financial Officer. Slide four highlights our footprint and financial scale. We operate 126 banking centers across Indiana, Michigan, and Ohio. Total assets stand at $21.1 billion, $15.6 billion in loans, $16.9 billion in deposits, and $7.1 billion in assets under advisement.

Turning to slide 5, third quarter net income totaled $67.8 million, or $1.09 per diluted share. Earnings per share are up 11% from the third quarter of last year and up nearly 30% from the third quarter of 2024. for, excluding a small amount of remaining acquisition-related expenses, adjusted earnings per share for the quarter totaled $1.10.

Last quarter, we said that we believe the key factors were in place for improved performance in the second half of the year. The third quarter delivered on that belief.

Net interest margin expanded six basis points to 3.44%. 4%, our highest margin in more than two years, and 20 basis points higher than the third quarter of 2025.

Fully taxable equivalent net interest income has grown 20% over the past year. Adjusted pre-tax pre-provision earnings totaled $83.7 million of 19% from a year ago, and an adjusted pre-tax pre-provision ROA totaling 1.59%. Return on assets was 1.30%, and return on tangible common equity was 15.09%. We also made meaningful progress with the two commercial credits we discussed last quarter.

Net charge-offs on those two loans were in line with the specific reserves we established in the second quarter. Non-performing assets were stable at 57 basis points of total assets. Credit costs for new non-accrual loans were recognized in prior quarters, keeping this quarter's provision expense to a modest $3.3 million.

Year-to-date net charge-offs of 38 basis points remains consistent with the full-year outlook we provided last quarter. Deposits grew $175.6 million, or 4.2% annualized, and non-interest-bearing deposits now represent 22% of total deposits. deposits. Loan growth was more modest at 1.8% annualized. Year-to-date results on slide six reflect the earnings power of a combined company now that first savings acquisition and integration are fully behind us, excluding acquisition-related expenses and the first quarter mortgage loan sale adjustment. Adjusted EPS totaled $2.87 of nearly 16% from the same period two years ago.

Adjusted pre-tax pre-provision earnings totaled $247 million of 18% from last year and 24% from two years ago. And our adjusted efficiency ratio improved to 53.85%. Our capital position remains strong. We completed a $100 million subordinated debt issuance in late September. Our total risk-based capital ratio increased to 13.58%, and we repurchased $50.3 million of common stock year-to-date, including $12 million in the third quarter. Tangible common equity was 8.83%, with the decline in tangible book value this quarter driven by the impact of higher interest rates on AOCI rather than our operating performance. Now, Mike Stewart will discuss our line of business momentum.

Thanks, Mark. Start on slide seven, business strategy. Our primary business strategy is to build on our Midwestern strength through disciplined organic growth. Our goal is to be the bank of choice across the Midwest earned through trusted relationships. Our four core business lines continue to work together to deliver financial solutions for businesses and consumers across the markets we serve. We are focused on driving organic growth by concentrating on the client segments in the markets where we hold a competitive advantage and by deepening relationships across our commercial and consumer banking lines of business. We have made meaningful progress building a stronger, more focused growth engine that is supported by deep client relationships, disciplined capital deployment, and continued investment in the capabilities needed to serve our clients and communities.

Our Midwest markets remain resilient, and our relationship-based model continues to create opportunities for growth. As we engage with clients every day, we see businesses investing, expanding, and seeking trusted financial partners who can provide our broad range of solutions. Turn to slide eight, a few more comments on loans. After a strong second quarter, third quarter loans, like Mark said, increased at 1.8% annualized rate, with strong growth coming from the construction and mortgage loan portfolio.

Overall, commercial loans were relatively flat as solid production did occur within our community and corporate banking segments, our asset-based and investment real estate teams, but that could not outpace the normal course payoffs within the sponsor, finance, and the shared national credit portfolios. Pipelines overall are stable, so loan growth should continue through the fourth quarter in the mid-single digits. Slide nine, deposits. We continue to focus on our deposit gathering and deepening relationships across both the commercial and consumer side of business.

Our objective is to support loan growth with strong core funding while maintaining a disciplined approach to balance sheet. Third quarter deposits grew at a 4.2% annualized rate with the consumer line of business and specifically the private wealth team driving the increase. We spoke last quarter about one of our clients selling a business, which resulted in a large and temporary increase in the commercial deposit base. That client has now moved those balances to our private client team for investment services and distributed some of the cash they need to do along the way. The 0.5% annualized year-to-date decline in total deposits is primarily now the result of balance sheet repositioning from the first quarter with first savings bank broker deposits being eliminated.

On a year-to-date basis, consumer non-mature deposits continue to show growth of 3% and net increases in households, and as noted on this page, our core commercial loans also grew. So I'll turn it now over to Michelle for her detailed summary of the balance sheet and income statement. Michelle.

Thanks, Mike, and good morning, everyone. Slide 10 covers our third quarter performance. Total revenues continue to grow in Q3 with net interest income increasing $2.1 million or 1.3 percent and non-interest income increasing $800,000 linked quarter. This resulted in healthy pre-tax pre-provision earnings for the quarter. Tangible book value per share of $28.86 decreased to $0.94 or 3.2% linked quarter due to the impact of AOCI from changes in interest rates during the quarter.

Slide 11 shows our year-to-date results. Lines 1 through 4 at the top of the page show the growth of our balance sheet over the past 12 months, with loans increasing $2 billion, or 14.6%, and deposits increasing $2.1 billion, or 13.8%. At the same time, the lower-yielding investment portfolio declined $258 million as we continued to shift our earning asset mix toward higher-yielding loans. Of the $2 billion increase in loans, the majority came from the acquisition of First Savings in the first quarter.

Excluding loans acquired from First Savings and the impact of the mortgage loan sale activity in the second quarter, we generated organic loan growth of $473.7 million, or 3.5%, over the past 12 months, reflecting continued demand across our markets. Looking at the income statement in the middle of the page, net interest income increased $74.3 million, or 18.7%, benefiting from growth and lower funding costs, and our year-to-date net interest margin of 3.39%, with 16 basis points higher than the same period in the prior year. income increased $17 million when excluding the $29.8 million loss on mortgage loans sold in the second quarter. Altogether, total revenue grew nearly 19% on a normalized basis, with first savings contributing approximately 13% of that growth.

Slide 12 shows the details of our investment portfolio. The bond portfolio declined $168 million linked quarter to $3.1 billion due to principal paydowns and maturities, as well as a decline in the portfolio valuation due to interest rate changes. Expected cash flows from scheduled principal and interest payments and bond maturities over the next 12 months told $271.4 million, with a roll-off yield of approximately 2.11%. 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 loan portfolio yield increased 12 basis points from the prior quarter to 6.23%. During the quarter, new and renewed loans originated at an average yield of 6.34% compared to 6.28% in the prior quarter, which continues to be a tailwind for the overall portfolio yield and reflects the pricing discipline from our team.

The allowance for credit losses is shown on slide 14. This quarter, we recorded $3.3 million in provision and had net charge-offs of $29.4 million. As a result the allowance for credit losses totaled million at the end of the quarter representing a coverage ratio of 1 Slide 15 shows details of our deposit portfolio. Total deposits grew to $16.9 billion this quarter, and the rate paid on deposits increased nine basis points to 2.16%, reflecting the competitive deposit pricing in our markets.

Next, slide 16 shows a continued favorable net interest margin trend. Our net interest margin of 3.44% increased six basis points for prior quarter and 20 basis points over the past year. The yield on earning assets shown on line 4 increased 10 basis points to 5.56% driven by higher loan yields, which more than offset the 4 basis point increase in interest expense shown on line 5.

When comparing to the same period in the prior year, the yield on earning assets nearly returned to that level in prior year, yet interest expense was 22 basis points less, creating an attractive earnings profile.

Next slide 17 shows the details of non-interest income, which totaled $38 million for the quarter, an increase of $800,000 over prior quarter. Customer-related fees shown on the bottom right of the page totaled $34.3 million and were consistent with prior quarter as growth in service charges, wealth management fees, and card payment fees offset a modest decline in gains on sales of loans.

Moving to slide 18, non-interest expense for the quarter totaled $116.3 million and included $900,000 in acquisition-related costs. Excluding acquisition costs, non-interest expense increased $3.9 million over prior quarter, driven by higher marketing expense, employee health insurance costs, and half a million on an impairment charge of a building lease.

Slide 19 shows our capital ratios. The tangible common equity ratio declined 16 basis points to 8.83% due to the impact of AOCI, but remains well above our 8% target. During the quarter, we repurchased 287,000 shares for $12 million, bringing total share repurchases year-to-date to just under 1.3 million shares for $50.3 million. The $100 million subordinate debt issuance we completed during the quarter increased our total risk-based capital ratio by 60 basis points, bringing it to 13.58%. We remain well capitalized with the common equity tier 1 ratio at 11.22% and are well positioned to support continued balance sheet growth and disciplined capital return. That concludes my remarks, and I will now turn it over to John Martin to discuss asset quality.

Thanks, Michelle, and good morning. My remarks begin on slide 20. Overall, the loan portfolio remains well diversified across commercial and consumer lending categories, with total loans of $15.6 billion at quarter end. Commercial real estate concentration levels remain well within regulatory guidelines with total CRE at 182% of total risk-based capital and construction at 42%, leaving meaningful capacity relative to the regulatory concentration thresholds of 300 and 100%, respectively. Within the commercial portfolio, line utilization remained stable at approximately 49%.

Shared national credit exposure declined to $936 million across 88 borrowers, while sponsor finance totaled approximately $811 million across 91 companies in diverse industries. Overall, these measures continue to reflect a diversified portfolio and a disciplined approach to concentration and structural risk management.

Turning to slide 21, third quarter asset quality activity primarily reflected the continued resolution and migration of previously identified problem credits rather than broad-based deterioration across the portfolio. We recognized approximately $29 million of charge-offs related to the authorized wireless retailer and commercial and residential roofing contractor discussed last quarter with the associated provision expense having been recognized in the prior quarter. We also moved two larger relationships to nonaccrual during the quarter, an $18.4 million auto parts distributor, and a $4.3 million digital marketing firm. Both had been under stress for multiple quarters and had already been downgraded, specifically evaluated, and specifically reserved in prior quarters before moving to non-accrual in the third quarter. That timing is important to understanding the quarter.

Although these relationships were newly reported as non-accrual in the third quarter, the expected loss content had already been recognized through specific reserves established in prior periods. Consequently, their migration to nonaccrual did not create a significant new provision requirement. As such, total third quarter provision expense of $3.3 million was deemed sufficient to cover growth, new credit migration, and the impact of the economic forecast. We expect these new nonaccrual relationships to be resolved during the fourth quarter.

Moving to slide 22, net non-performing asset migration was essentially flat during the quarter. New non-accrual inflows, including the two relationships just discussed and several smaller additions, were offset by charge-offs and other resolution activity. The significant charge-offs recognized this quarter were tied to the loss content of credits that moved to non-accrual last quarter and had been reserved for at that time.

In summary, reported credit activity remained elevated as we continued to work through a limited number of known problem relationships. However, the quarter did not reflect a comparable increase in newly identified loss content. The largest charge-offs were previously provided for, and the largest new nonaccruals had specific reserves established in prior quarters. Outside of these relationship-specific credits, portfolio performance remains generally stable. We remain focused on proactive portfolio management, timely recognition of risk, discipline reserving, and the orderly resolution of problem assets. I'll now turn the call back over to Mark.

Thanks, John. Turning now to slide 23, our long-term track record of shareholder value creation remains a key strength and a priority. Over the past decade, earnings per share has grown at an 8.5% compound annual growth rate, dividends per share at 13.3%, and tangible book value per share, including AOCI, at 8.5%. Slide 24 highlights our 11.2% total asset kegger over the past decade, reflecting a consistent strategy of organic growth complemented by disciplined value-accretive acquisitions that expand our demographic and geographic footprint.

Before we open the line for questions, I'd like to take a moment on a more personal note. As we previously announced, I will retire at the end of this year, and Mike Stewart will succeed me as Chief Executive Officer. As such, this is my final earnings call. I joined First Merchants in November of 1997 as corporate controller.

Over the past 29 years, I've been privileged to serve as chief financial officer, chief operating officer, and now chief executive of those last three positions over a 24-year period. I couldn't have asked for a better place to spend my career. To our 2,200 teammates, thank you. Your dedication to our clients and our communities is what makes First Merchants special.

And it's been an honor. It's been the honor of my professional life to work alongside all of you. To our clients, thank you for trusting us with your financial lives and your businesses. To our board of directors, thank you for your guidance, your support, and your confidence over many years. And to our shareholders and the analysts on this call, many of whom I've known since my early days as Chief Financial Officer, thank you for your interest, your challenging questions, and your investment in First Merchants.

Those conversations have made us a better company. I have great confidence in Mike. He's been a trusted partner for 18 years. He knows our clients. He knows our markets. He's built strong teams across all of our lines of business. And together with Michelle, John, and the rest of our leadership team, Mike and First Merchants is well positioned to build on our Midwestern strength, deepen our client relationships, and deliver sustainable earnings growth and shareholder value. The company, this company, is in excellent hands, and I look forward to cheering on First Merchants as a shareholder.

Thank you for your continued support and investment in First Merchants. And, operator, we are ready to take questions for the last time.

Yeah, let me, Daniel, let me clarify. We're not going to charge off the full amount of those loans. And I think the way to think about it, last quarter I guided for a full year between 40 and 45 basis points for the year. And then kind of after reviewing those names and the portfolio for the end of the year I would probably guide towards the lower of those two It probably closer to 38 to 40 basis points for the remainder of the year. Not for the quarter, but for the full year annualized, or for the full year. Does that make sense?

You know, I think in terms of the reserving level, at this point, you know, the reserving is going to largely be related to portfolio growth for, again, into the fourth quarter. As it relates to specific reserves or new specific reserves into the fourth quarter, I'm not seeing or expecting anything at this point outside of what's previously been specifically reserved for.

No, you know, both the criticized and classifieds were up somewhat for the quarter, but it wasn't related to, you know, an individual large name or anything like that. It's just kind of normal migration that we see quarter to quarter. higher rates do have an impact in portions of the investment real estate portfolio. But it's not really a broad-based concern that I have as it relates to the portfolio. It's just kind of new migrations that kind of come in and go out. We're constantly reviewing the portfolio and looking at grades and how the borrowers are performing. In any given quarter, you can see an uptick or a downtick. But there's nothing there that I, you know, am concerned with at the moment.

Oh, from a provision or a charge-off perspective. You know, I had been kind of pre the last quarter saying it was between 15 and 20 basis points. I'd say probably on a more normalized basis, we're probably in the 20 to 25 basis point range, would be a normal, kind of a more normalized charge-off run rate.

And in terms of the provision expense, it'll just obviously keep up with that, Michelle. Yeah, and just to give you a little more color around provision, I mean, I think once we have these other large credits resolved and coming out of non-performing in Q4, I would expect the specifics maybe to resolve around $10 million or so. So when you think about the coverage ratio, it'll be somewhere between like that mid-138. It'll be, you know, low to mid-130s. And that kind of coverage ratio is what we'll expect to have going forward with new growth.

Sure. Mike Stewart here. Go back to your first part of that question. The muted loan growth this time was as much just the management of a portfolio that sat really inside the sponsor and that shared national credit where we're selectively choosing where we want to play and how much we want to continue to grow that portfolio. if you look at the rest of the production level through the commercial book of business that what we call the community corporate bank and the investment real estate and what we do with asset-based lending there was really good production numbers in those so which is what I like and to that point those pipelines continue to be at really good levels and the expected payoffs and or purposeful credit exits probably won't be at that same level in the fourth quarter.

So back to that mid-single-digit expectation of loan growth. And like I said, I'm seeing it through our geographies, and I'm seeing it through how we segment or go to market on our commercial business lines. When I go back to your second part of that question, interest rates and impact. Well, the pipeline on our consumer mortgage is definitely showing softness.

You get mortgage rates that have a seven. You know, the refi business was already kind of slow. Well, now it's nil. And purchases just become a little bit less active, so to speak. So the pipeline on the consumer mortgage side is definitely being impacted now. That level is still a good level. It's just not where it would have been a year ago when we look at the year over year, understanding seasonality and quarter over quarter.

When you look at, and to John's point maybe, when you look at where the interest rate impacts would be on a commercial portfolio, it's not bringing credit issues to bear, but it is having certain real estate projects potentially be rethought or business owners rethinking how they want to potentially do some capital expenditures or do an acquisition. So that is just an end-of-the-year mentality maybe. Maybe it's interest rate. Maybe it's still a little uncertainty with tariffs and the general temperature throughout business minds. But right now, I don't view interest rates hurting demand except for on the consumer mortgage.

Yeah, good morning. Well, looking at our Q4 margin, I mean, we would expect our Q4 margin to be stable. You know, normally when we get a rate increase like we did in September, we would see our margin tick up a basis point or two because of our asset-sensitive balance sheet. And the fact that we've got some really great tailwinds on asset repricing, you know, not only on the loan side, but also on the bond portfolio.

But I just wanted to remind you, I mean, this fourth quarter will be the first quarter that we'll be absorbing a full quarter of interest expense from the subdebt. So that will offset a little bit of that increase. When I look at September, our September loan yields were down a little bit just simply because we had kind of flat growth in September and loan fees were lower. So I don't really use September kind of as an indication of where I think it's going to go. I feel like fourth quarter will be – when you look at third quarter to fourth quarter, we should see loan yields increase, interest income increasing.

And so once we kind of normalize with our subdebt expense, I think when you look into 2027, we'll continue to see a little bit of lift in margin.

Yeah, it is higher. This quarter was more elevated than we had guided, and really it kind of came from a strategic decision we made to invest more in marketing and branding, not just this quarter, but even on a go-forward basis to help us kind of win organically, particularly in the deposits in our markets. And so I do think this Q3 run rate is a good run rate to use for Q4. And I think when we look into 2027, as I've guided before, I think a 3% to 5% expense increase on top of that is really what I think would make sense for us.

Yeah, I mean, for fourth quarter, I mean, I feel, well, I should say first, we had just a couple of one-time items, some CRA income and so forth. It really amounted to maybe about $700,000. It was relatively muted. That won't recur in Q4. And as Mike said, you know, I do think that maybe gains on the sale of loans could be a little bit softer. But by and large, we feel like we should be able to deliver a pretty consistent level of fee income in Q4 that we did in Q3. And talk about the new verticals that we have and some of the gain on sale we wouldn't have had this time last year.

When I think about the SBA business and the first lien HELOC business, we're picking up some gain on sale there that we wouldn't have had a year ago.

Yeah. Yeah I mean I think when we look at particularly the client fee categories which we break out on our slides you know we do expect those categories to grow kind of in that higher single digit somewhere between like that you know 8 to 10 rate So that is what we would expect for 2027.

Yeah, definitely. You know, we were in a quiet period, really, I think, so far through this quarter, just because of earnings and other announcements and so forth. But we will use some of that sub-debt to buy back shares. And so I think you'll see an elevated level of share buyback in Q4, maybe potentially in Q1 as well. but it is our intention to continue to stay in the repurchase game.

Thank you, Damon.

Yes. Yeah.

Yeah. I'll hit a little bit on that. We are remaining opportunistic and open to what might be coming our way, especially in the Michigan market. We're now on the back end of the integration of the FIFTA ProAmerica, and individuals are becoming available. So we're actively looking at where we could add bankers that would immediately add value. So if there's any increase on the salary side, I would expect to see the resultant increase on level of production.

When you think about other areas in which right now I feel like we've got a really strong core team, And we've built out and invested in some teams the last 18 months that have been benefiting us. So, perhaps the Michigan market, I think that's about the only place we will continue to look heavy at.

Yeah, we've been talking a lot about those things. I want to go back a little bit that, you know, Mark's retirement really is nothing more than his opportunity in front of him. And so the consistency of First Merchants and continue to execute with the existing executive team and the senior management team for me is job one is to build that consistency and assure that our clients and the rest of our teammates and you, our shareholders, have great comfort in that. As we look into 2027, we can look at things from a budget point of view, but we're also looking at things strategically. And we're really deep into an initiative that I started and Mark's been supportive of a year ago to really analyze and build a strategic plan that helps us with choices.

We've got a nice varied balance sheet. We've got opportunities to continue to improve how we want to resource our teams and our staff, and we're going to make those come to life. It's all in the idea that we can continue to grow our earnings per share and our tangible work value and the means that brings us back to some really strong valuation.

14%. I think would be a good effective tax rate to use for the modeling.

Well, we can both do it together. I think that where we're still seeing the best momentum and you see it continue in our pipelines is what we call in our community and our corporate bank. So in the market, bankers working with the businesses that are right in our backyards, good CNI activity, outworking our competition, being in the Midwest, offers us some stability and growth opportunities as the owners are evaluating their plans into 2027. That's where I see the continued growth happen.

Yeah, and I would agree. the opportunities that we continue to see are core CNI and even on a somewhat accelerated basis, the ABL, the Asset Based Lending Portfolio, where you have borrowers who need liquidity to grow their businesses. And we have a real quality group of individuals that have the controls and portfolio management skills that have allowed us to originate some real nice opportunities. So a couple of places there, investment real estate, you know, with higher rates, it does have an impact. But, you know, as long as they meet the capital hurdles, we still are finding opportunities there as well as some low-income housing tax opportunities. Still continue to see those as well. So a lot of opportunities across the portfolio.

Yeah, those are, you know, in some segments, part of that commercial pipeline, it's modestly up quarter over quarter. I also look at things year over year, and it's stable to that means as well.

Sure. Yeah. So, you know, with each 25 basis point rate hike, we typically see margin increase one to two basis points. And so, as I said, you know, normally we would see one to two basis point lift with the September rate hike. But we are adding the cost of the sub debt, which will will partially offset that. But I think if we get an additional rate hike or two, you'll see some of that additional lift. And so I think that's the way you can think about it. On the fixed rate portfolio, over the next 12 months, we've got about $350 million that's at a $490 rate that will reprice.

It's a little bit of both. Those account declines were, you know, they were coming up for just normal renewals or had some request in front of us. And, you know, we always look for how well we cross-sell the opportunity, what's the return we're getting on the opportunity, and where does it fit within our hold levels. And all those transactions felt like they were ones we would be better not participating in.

I don't really have a good view on what's coming at us in the fourth and the first quarter as far as what's on their minds. But we've got a really strong team in that area as well. And we do have some fantastic relationships in that book of business. So it's just like anything. We look at it on an individual basis each time. And it'll be something that we'll evaluate. But I don't think there's any changes in front of me right now. I'm looking at John as I say that.

Yeah, I would just repeat the first part of Mike Stewart's answer in that we're looking at them transaction by transaction. It's not like we've instituted a core portfolio model change or something of that nature. We look at relationships as they come up, and I think from my seat as they come through and we discuss them, We're looking at the pricing, the cross-sell, the opportunity, how it fits to certainly what happened last quarter as it relates to, you know, potential for loss and how much, you know, maybe unsecure, not unsecure, but error, to use a term, in the transaction. but it's a risk management and return exercise.