FIRST MERCHANTS CORP (FRME) Q2 2026 Earnings Call Transcript

Thank you for standing by. And welcome to the First Merchants Corporation Second Quarter 2026 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 condition of First Merchants Corporation. Those involve risks and uncertainties. Further information is contained within the press release, which we encourage you to review. Additionally, management would 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 a reconciliation of GAAP and non-GAAP measures. As a reminder, today's call is being recorded. I would now like to turn the conference over to Mr. Mark K. Hardwick, CEO. Mr. Hardwick, you may begin.

Good morning, and welcome to First Merchants' Second Quarter 2026 Conference Call. For the introduction and for covering the forward-looking statement on Page 2, we released our earnings yesterday after markets closed and today's presentation materials are available via the link on Page 3 of the earnings release. Turning to Slide 3, you will see today's presenters and members of our executive management team. Joining me on the call are Mike Stewart, our President; John J. Martin, Chief Credit Officer; and Michele Kawiecki, our Chief Financial Officer. Slide 4 highlights our footprint and financial scale. We now operate 126 banking centers reflecting the addition of Southern Indiana following the First Savings acquisition. Total assets stand at $21.3 billion with $15.5 billion in loans and $16.8 billion in deposits. Turning to Slide 5: second quarter reported net income totaled $43.5 million, or $0.70 per diluted share. Second quarter results were negatively impacted by two loans that were moved to nonaccrual status with specific reserves taken against them. We are disappointed by these two downgrades and we are confident they are not representative of the overall portfolio. We remain confident in our outlook, as John will highlight later in the presentation, and we are happy to answer any questions that you might have during the Q&A session. Adjusted pretax, pre-provision earnings increased to $84.6 million for the quarter, an increase of 7.5% over the first quarter of 2026. Net interest margin expanded to 3.38%, and loan and deposit growth returned to more traditional levels. Year-to-date net income on Slide 6 totaled $71.2 million. Excluding the mortgage loan sale from the first quarter and acquisition-related expenses from both the first and second quarter, adjusted EPS totaled $1.77 per share. The previously announced mortgage loan sale is now complete, adding $271 million of liquidity to our balance sheet. Our integration and related expense savings are now complete and position us well for next quarter. Our balance sheet continues to grow organically reflecting strong production levels. Tangible common equity remains strong at 8.99%, and we continued our share repurchase activity throughout the first half of this year. All of these factors position us well for improved performance during the second half of 2026. And now Mike Stewart will discuss our line-of-business momentum.

Thank you, Mark, and good morning to all. Our business strategy is summarized on Slide 7. As stated at the top of the slide, building our Midwestern strength by growing organically remains our primary objective as a company. Our four primary business units work together in delivering financial solutions for businesses and consumers focused primarily on the markets you see starting on Slide 8. After a flat first quarter of loan growth, the second quarter picked up the pace with nearly 6% annualized growth both in the commercial and consumer business segments. The increase came within our three-state footprint and was driven by the community, corporate, asset-based, and investment real estate themes, working with our current client base and adding new names. Our Midwest economies continue to expand, our clients' businesses continue to grow, and our bankers continue to win new relationships. The same is true for the consumer teams within small business, mortgage, and private wealth. The full loan portfolio trend is summarized on Page 27 for your reference. We remain confident in our expected mid-single-digit loan growth through the end of 2026. Turning to Slide 9: deposits. Second quarter deposits grew at a 6.5% annualized rate. The robust commercial growth was primarily attributable to public fund increases due to seasonal tax collection and a large temporary deposit increase from a client's sale of their business. This client is working with our private banking team on investment management and trust service solutions for their family. The large consumer decline was also seasonal and primarily due to consumer tax refund payments being spent. The seasonality of tax payments between public entities and our consumer deposit accounts will normalize for the balance of the year. The 3% year-to-date decline in total deposits was due to declines in maturing deposit balances and the balance sheet repositioning of the First Savings brokered deposits in the first quarter. On a year-to-date basis, consumer nonmaturity deposit balances grew 3% with net increases in households. Michele will be reviewing our continued net interest margin improvement which was a direct result of disciplined deposit and loan pricing.

Thanks, Mike, and good morning, everyone. Slide 10 covers our second quarter performance. There was meaningful growth in total revenues during Q2. Net interest income grew $7.6 million and noninterest income grew $1.6 million linked quarter after normalizing for the $29.8 million loss recorded on mortgage loans sold in the first quarter. Strong revenue growth along with disciplined expense management resulted in overall pretax, pre-provision earnings of $84.6 million, increasing $5.9 million over the prior quarter and generating 2% positive operating leverage. Tangible book value per share of $29.80 increased $0.46, or 1.6% linked quarter. Slide 11 shows our year-to-date results. Lines 1 through 3 at the top of the page show that we continue to grow the balance sheet towards a more favorable earning asset mix as we have reduced our lower-yielding bond portfolio along with lower-yielding mortgage loans during the first six months of the year and redeployed the capital into higher-yielding loans. Looking at the income statement in the middle of the page, total revenue grew 18% when comparing year-to-date 2026 on a normalized basis to the same period in 2025, with First Savings contributing 12% of that growth. Pretax, pre-provision earnings totaled $163.3 million, reflecting growth of $25.2 million, or 18.2%, over the same period in the prior year. Year-over-year tangible book value growth was strong, increasing $1.90, or 6.8%. Slide 12 shows details on our investment portfolio. The bond portfolio declined modestly, as principal paydowns and maturities were offset by positive changes in portfolio valuation. Expected cash flows from scheduled principal and interest payments throughout the remainder of 2026 total $156.2 million with a roll-off yield of approximately 2.69%. We plan to continue to use cash flows generated from the bond portfolio to fund higher-yielding loan growth for the remainder of the year. Slide 13 covers our held-for-investment loan portfolio. The total loan portfolio yield increased by 2 basis points from the prior quarter to 6.11%. During the quarter, new and renewed loans originated at an average yield of 6.28%, compared to 6.18% in the prior quarter, demonstrating strong pricing discipline by our team. The allowance for credit losses is shown on Slide 14. This quarter, we recorded $33 million of provision due to specific reserves of $29.7 million that were established on two commercial credits, which John J. Martin will cover in more detail in his remarks. Net charge-offs totaled $3.9 million for the quarter. As a result, the allowance for credit losses totaled $241.6 million at the end of the quarter, representing a coverage ratio of 1.56%. Slide 15 shows details of our deposit portfolio. The rate paid on deposits continued to decline to 2.07% this quarter, and our funding mix improved favorably. We used the proceeds of $271 million from the mortgage loan sale that closed in late June to reduce higher-cost brokered deposits and wholesale funding. Next, Slide 16 shows a favorable net interest margin trend. Net interest income on a fully tax-equivalent basis of $165.3 million increased $7.6 million linked quarter and $26.1 million from the same period in the prior year. While we have an asset-sensitive balance sheet and endured Fed rate cuts in the fourth quarter of 2025, the yield on earning assets shown on line 4 only declined modestly while the cost of funds shown on line 5 has been reduced substantially. The pricing discipline on both sides of our balance sheet has created margin expansion through the first half of this year. Next, Slide 17 shows the details of noninterest income which totaled $37.2 million for the quarter. Customer-related fees were strong with notable quarter-over-quarter growth in gains on sales of loans and derivative hedge fees. Moving to Slide 18, noninterest expense for the quarter totaled $115.3 million and included $3.8 million in acquisition-related costs. The acquisition costs were primarily incurred in professional and other outside services and equipment expense categories. The cost synergies we expect to gain from the First Savings acquisition are on track. Slide 19 shows our capital ratios. The tangible common equity ratio was 8.99% and stable compared to the prior quarter. Since the beginning of the year, we have repurchased just under 1 million shares for $38.3 million year-to-date. We remain well capitalized and are positioned to support continued balance sheet growth and disciplined capital return. That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John J. Martin, to discuss asset quality.

Thanks, Michele, and good morning. Overall, the portfolio continues to perform within expectations and remains well diversified across commercial and consumer lending categories. Total loans ended the quarter at $15.5 billion. Commercial real estate concentration levels remain comfortably within regulatory guidelines, and our credit portfolios continue to largely perform in line with expectations. Second quarter asset quality was impacted by two notable credits. The larger of the two relationships was a $28.1 million participation in a syndicated credit to an authorized wireless retailer. Subsequent to quarter end, we received company-specific information that led us to place the loan on nonaccrual. While negotiations with the borrower remain active, the outcome has not yet been finalized. However, we expect to have substantially greater visibility into the likely resolution by the end of the fourth quarter. The second credit was a sponsor-financed $13.7 million loan to a commercial and residential roofing contractor that had been on the watch list for three quarters. It was placed on nonaccrual in July after the sponsor informed us that they no longer intended to support the company. While meaningful in size, this credit is more representative of the type of periodic C&I migration we see from time to time within the commercial loan portfolio. As a result, nonaccrual loans increased to $118.2 million, and nonperforming assets plus 90 days past due increased to $129.5 million, or 0.83% of loans. Classified loans increased to $393.3 million from $357.1 million last quarter. While these metrics moved higher, the increase was driven primarily by a limited number of borrower relationships—most notably the authorized retailer and roofing contractor credits—rather than broad-based deterioration across the portfolio. Looking ahead, we expect a meaningful portion of the loss content associated with these two nonaccrual relationships to be realized through charge-offs during the third and fourth quarters. As a result, while current quarter charge-offs remained modest at 10 basis points annualized, we currently anticipate full-year 2026 net charge-offs will trend into the 40- to 45-basis-point range. Importantly, that expectation is largely driven by the resolution of these known credits and should not be interpreted as a change in our view of the broader portfolio, which continues to perform within expectations. We remain focused on proactive portfolio management, early identification of emerging risks, and maintaining the strong discipline that has consistently differentiated our organization. Thanks for your attention, and I will now turn the call back over to Mark K. Hardwick.

Thanks, John. Turning to Slide 21: our long-term track record of shareholder value creation remains a key strength and a key priority for this management team. Slide 22 highlights our 11.5% total asset combined annual growth rate over the past decade, reflecting a consistent strategy of organic growth complemented by disciplined, value-accretive acquisitions that expand our demographic and geographic footprint. We look forward to building on our Midwestern strength throughout the rest of 2026 by focusing on our people, clients, products, and technology investments—or simply running the core bank. Seeing this strength translate into earnings per share and sustainable earnings growth and shareholder value remain our top priority. Thank you for your continued support and investment in First Merchants. And now we are happy to answer any questions that you may have.

Certainly. As a reminder, to ask a question, please press 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press 1-1 again. Our first question will come from the line of Daniel Tamayo of Raymond James. Your line is open, Daniel.

Thank you. Good morning, everyone. Maybe just starting: I appreciate all the color on the two credits that drove the issues on the credit quality side this quarter. But seeing as one of them was from the shared national credit book, maybe for you Mark, just curious how you are thinking about that business overall from a go-forward basis? Are you still comfortable with it? Are you still growing that business? And then if you have any maybe details on reserves of the rest of the book in terms of how that looks relative to the overall portfolio, that would be helpful.

Yeah, Danny, I will start, and then if John or Mike want to add anything, they can. We still like the business and like the balances that we have on our financials. It is really because we focus on customers that are in our backyard that happen to be large enough to participate in the SNC market. This particular customer is one where we have had a relationship; they are in the Michigan market, kind of in our backyard, and are involved in a couple of other local businesses that are unrelated. Those are the types of credits where we tend to have great relationships with management and continuous dialogue, and I think that is reflective of the entire SNC portfolio. We are not just buying credits to expand the balance sheet from outside of our core markets. We focus on those customers that we are close to. The rest of the portfolio—I do not have specific additional concerns. It is not an area where we have experienced challenges in the past. I would open it to these two guys if they have anything else to add.

I would echo Mark's comments. This relationship expanded into ancillary businesses beyond the current exposure; that was isolated to this particular borrower. We have other loans and deposits with similar borrowers, and that is how we approach the Shared National Credit portfolio. Borrowers who in aggregate have more than $100 million in borrowings and have relationships with more than two banks make up that category. You can look at total outstanding and average balances and it is relatively granular. We try to approach it in a granular way and use it as a lever to expand a relationship, and that really is our strategy.

Mike Stewart here. One last comment: all that Mark said and John said. That being said, we will do a complete portfolio review of our shared national credit. We need to understand better asset coverage versus cash-flow lending, so there will be analysis on that. But I want to reinforce what Mark said: we have access to management; these are companies in our backyard; we feel we have an understanding of how we can work with them beyond just a purchase of a loan. Clearly disappointing, but we will do a portfolio review and make sure we feel absolutely comfortable with our approach.

Thanks for all that color from all of you. Appreciate that. I guess next for Michele, just if you can give us—you mentioned that cost savings are on track for savings—any kind of outlook you might be able to provide on the expense numbers and maybe how you are thinking about where that might land post-integration efforts?

Yeah. So our quarterly run rate—guidance I gave last quarter—was that we thought through the remainder of the year our total expense run rate would be between $111 million to $114 million per quarter, and I still think that is good guidance. If you strip away some of the noise we had this quarter, we kind of land in at that $111 million spot. With some hiring that we are doing there will be a little bit higher expense balance, but I think that range is still appropriate.

Alright. Thank you for that. Appreciate it. I will step back.

And our next question will be coming from the line of Russell Gunther of Stephens. Your line is open, Russell.

Hey, good morning, guys. First, with just a quick follow-up on the expense commentary. Helpful to get the reiteration for the rest of this year. As we think about the go-forward, what is a safe, kind of normalized growth rate to assume based on franchise investment, hiring initiatives, etc.?

Well, this year normal organic growth is between 3% and 5%. That reflects investing in the business and in talent. We have historically talked about specific places like our asset-based lending team and other commercial hires. I think that range on a go-forward basis will still hold true because we will continue to do some hiring and invest in technology.

Okay. Excellent. And then switching gears to the margin: it would be helpful to get a sense for how you are thinking about the back half of this year—whether you are contemplating any Fed hikes in your outlook—and maybe starting on the loan side where you expect yields to trend?

I will start with margin. We are assuming no Fed rate changes through the remainder of the year. If that is the case, then we would expect margin to increase maybe a couple basis points in the back half of the year. We are seeing some high CD specials from competitors in our markets, so pricing deposits is always a variable in maintaining our deposit costs. We have some tailwinds: some fixed-rate assets on both the loan and bond side that will be repricing, and we feel pretty good about being able to achieve stability to up a couple basis points. Regarding loan yields, our new and renewed loan yields remain above our overall yield, and that is helping to drive net interest income.

I think Michele summarized it well. That should be consistent on a go-forward basis.

Okay. Great. Thanks for tackling both sides of that margin question for me. I will step back.

I was really pleased to see the new and renewed loan yield move from 6.18% last quarter to 6.28% this quarter.

And it does create momentum over the portfolio yield at 6.11%.

And our next question will be coming from the line of Damon Del Monte of KBW. Damon, your line is open.

Hey, good morning, everyone. Hope you are doing well today. Just wanted to start off with fee income and maybe the outlook there, Michele. Mortgage banking and organic loan sales had a solid quarter. How is the pipeline shaping up in the third quarter and what might you expect moving off this quarter's $37.2 million level?

For the full year, we would expect noninterest income to be up 10% over prior year. There is seasonality in the mortgage business, but we had a solid quarter with gains on sales of mortgages, and I would expect similar performance next quarter.

Okay. Great. And then regarding capital management, a question for Mark on your thoughts about continuing the buyback. Good to see you are active again in the second quarter and capital levels remain healthy. Did the two credits weigh on your capital-allocation decisions and can we expect more buybacks going forward?

We expect to continue buyback activity through the remainder of the year, assuming our stock price stays in a similar range. The $100 million approval we received from the Fed and our Board was announced. We continue to generate capital: roughly 30% to 40% supports loan growth, about a third goes to dividends, and the rest is available for other purposes. At this point, we think share repurchase is still a good use of capital.

Okay. Great. I will leave it at those two questions and step back. Thank you.

And our next question will be coming from the line of Brendan Nosal of Hovde Group. Your line is open, Brendan.

Hey, good morning, everybody. Hope you are doing well. Maybe to circle back to credit and the syndicated loan: can you fill us in on where that credit was risk graded last quarter? What changed in their operations that drove the downgrade? And are there any read-throughs from that situation to other commercial credits or other syndicated credits you have?

Brendan, in the first quarter we identified the beginning of the issue and moved it to our watch list. In the second quarter we moved it to classified. That was a significant portion of the change in the classified numbers. We do have other exposure in the wireless retail space, but the issues were specific to this particular carrier. We continue to perform portfolio reviews on our shared national credits and have an understanding of the overall exposure.

I would add that the carrier has made a dramatic shift in their retail distribution model and it is impacting this customer directly. The changes moved quickly, and the impact became much more apparent late in the quarter and even subsequent to the quarter. That provides a bit more color on timing.

We did receive additional information subsequent to the first quarter that was present in the second quarter, which informed our actions.

Okay, that is very helpful color. Thanks. Maybe pivoting to the First Savings acquisition: you are six months or so into that deal now. Anything you have learned from being on the ground longer? Anything new on their specialty commercial verticals that has changed over the course of the year?

That is a good question. I did not speak a lot to it earlier. Our local commercial team down in Jeffersonville, led by Eric Howard, is off to a great start. We have done a good job integrating: the commercial activity is good and actually grew in the quarter after the flat first quarter. The consumer book down there is doing reasonably well; you see some attrition in units but overall balances are within our model since the legal close in February and integration in May. We have a marketing campaign, are opening new accounts, and managing normal attrition. As for verticals: the SBA business continues to do well nationally—originations were basically flat to the first quarter and we sell the guaranteed portion quarterly; that activity is good. The first-lien HELOC business showed originations up about 10%, and that is primarily an originate-and-sell process so that activity is positive. The triple net lease business had robust growth in the quarter. Overall, the specialty verticals are behaving as expected: stable providers of balance-sheet opportunities and fee income. The team is stable and the opportunities to grow in Southern Indiana as a core commercial bank are off to a good start.

Awesome, that is very helpful color. Thanks for taking my questions.

And our next question will be coming from the line of Nathan Race of Piper Sandler. Your line is open.

Hi, everyone. Good morning. Thanks for taking the questions. Going back to credit: John, when you look at classified loans and how they have turned up by roughly $100 million over the last couple of years, can you shed light on what is driving that increase? Are you being tougher graders these days, or are there changes in the portfolio complexion? Any thoughts on when we might see classified loans start to trend lower?

You look over the last couple of years and you see a couple of things. One, we are a larger organization and we have added overall balances, so in absolute dollars some increase is expected. If you look year-over-year, we are actually down: Q2 2025 our ratio was 2.80%, and today we sit at 2.53%, so we are down year-over-year. Higher interest rates previously impacted investment real estate and construction portfolios, which played a role. We are consistent with our grading methodology; I would argue we are tougher with our grading than some peers, but I may be biased.

Okay, that is helpful. Mark, you have been consistent that you are not really looking for acquisitions and are internally focused. Curious for any updated thoughts on M&A appetite for smaller or transformational opportunities these days?

Our focus is the same: we are proud of our bank and its earnings engine. We are focused on executing, taking care of employees and customers, and driving shareholder return. Activity is quiet in our three-state footprint regarding institutions interested in a transaction. If something piques our attention, it would need to be easy to digest, have a strong deposit base, and a low loan-to-deposit ratio. Many banks are looking for similar characteristics right now.

Makes sense. Michele, I apologize if I missed it earlier, but any thoughts on the effective tax rate going forward?

I think 13% would be a good effective tax rate to use. That is what we are expecting.

Okay, great. I appreciate all the color. Thanks.

And our last question will be coming from the line of Brian Martin of Bryn Mawr Capital. Your line is open, Brian.

Good morning, everyone. Just one or two for me. Michele, earlier you commented on fixed-rate asset repricing—can you remind us what that amount is? I may have missed it.

On the loan side, we have about $385 million repricing over the next 12 months. Those loans are sitting at about a 4.5% to 4.6% rate, so there is upside there.

Okay. And maybe on the pipeline and the acquisition: can you comment at a high level where the loan pipeline is today and where you are seeing strength or expect continued strength?

On the consumer side, which includes our mortgage pipeline, that is where the strength remains. The mortgage pipeline is up substantially compared to a year ago; it is seasonal, but we have invested in producers and the efficient back-office allows us to grow units. I view the commercial pipeline as stable relative to the end of the first quarter; you saw nice growth in the second quarter after a flat first quarter. The pipeline is evenly dispersed across our geographies with strong growth in Michigan, and Eric's work in Southern Indiana is contributing nicely. Our asset-based lending team's pipeline and production have also been strong. Overall, the commercial pipeline is stable and supports our expectation of mid-single-digit growth into the third and possibly fourth quarter.

Got it. That is helpful. Michele, on the securities portfolio you noted you plan to use cash flows to fund loan growth. Where do you see the securities portfolio in size longer term? Any target as you draw it down a bit?

Generally, our bond portfolio is about 15% of total assets, which is about where we are today. Fair value is impacted by rate movements, so we will continue to monitor it. At least through the remainder of this year we plan to use cash flows to fund loan growth. The roll-off yield I mentioned earlier is approximately 2.69%.

Okay, thank you for taking the questions.

Alright. Thank you, Brian. I would now like to turn the call back to Mark for closing remarks.

Thanks, everyone. We appreciate your investment in First Merchants and your interest. The first half of the year has been a little noisy—some things we are excited about and some we are disappointed by. To have our acquisition complete and fully integrated, to have our loan sale complete and to put that liquidity back to use at a much higher yield has been great for the business. Obviously, we are disappointed by the two commercial credits that challenged the second quarter, but I am really enthusiastic and excited about what the second half of 2026 should represent for our company. I look forward to talking to you about a strong second half in 90 days. Again, we appreciate your time and attention. I look forward to talking to you in a few months. Thank you.

And this concludes today's conference. Thank you for your participation and have a great day. You may now disconnect.