First Merchants Corporation (NASDAQ:FRME) Q3 2022 Earnings Conference Call October 25, 2022 10:30 AM ET
Company Participants
Mark Hardwick – CEO
Mike Stewart – President
Michele Kawiecki – CFO
John Martin – Chief Credit Officer
Conference Call Participants
Scott Siefers – Piper Sandler
Daniel Tamayo – Raymond James
Damon DelMonte – KBW
Brian Martin – Janney
Operator
Good day and thank you for standing by. Welcome to the First Merchants Corporation Third Quarter Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded.
Before we begin, management would like to remind you that today’s call contains forward-looking statements with respect to the future performance and financial condition of First Merchants Corporation that involve risks and uncertainties. Further information is contained within the press release, which we encourage you to review.
Additionally, management may refer to non-GAAP measures, which are intended to supplement but not substitute for the most directly comparable GAAP measures. The press release available on the website contains financial and other quantitative information to be discussed today as well as a reconciliation of GAAP to non-GAAP measures.
I would now like to hand the conference over to your speaker today Mark Hardwick, Chief Executive Officer. Please go ahead.
Mark Hardwick
Good morning and welcome to the First Merchants third quarter 2022 conference call. Michele, thank you for the introduction and for covering the forward-looking statement on page 2. We released our earnings today at approximately 8:00 AM Eastern. You can access today’s slides by following the link on the second page of our earnings release.
On Page 3, you will see today’s presenters and our bios to include President, Mike Stewart; Chief Credit Officer, John Martin; and Chief Financial Officer, Michele Kawiecki. Page 4 is a snapshot of the First Merchants geographic footprint and some relevant financial highlights for your review.
Given the close of Level One Bancorp on April 1 of this year, you will notice an updated banking center map highlighting are now 122 locations across four states. We also continue to receive meaningful awards for customer service, leadership, work life balance and performance from publications like Forbes, Newsweek, S&P and comparable.
Now if you would turn to Slide 5, reported earnings per share for the third quarter totaled $1.08 compared to Q3 2021 results of $0.98, when adjusted for PPP income and Level One acquisition expenses, our Q3 2022 EPS totaled $1.12, an increase of $0.25 per share or $0.29 over Q3 2021’s adjusted total of $0.87 per share.
Organic growth in loans of 10% for the quarter and 13.5% year to date when combined with core margin improvements of 28 basis points for the quarter and 23 basis points year-to-date are the drivers to our EPS improvements.
Our system integration of Level One is complete and was exceptional in many areas and more challenging than anticipated than others. Our teams in both Michigan and our legacy markets quickly resolved issues with professionalism and customer service mindset that makes me proud.
We also continue to streamline the branch network as evidenced by five completed consolidations in 2022. The year-to-date earnings per share story when normalized for PPP income and acquisition accounting resulted in year-to-date 2022 earnings per share of $3.01, which is 18.5% better than our 2021 total of $2.54.
Third quarter return on assets of 1.43% and return on tangible common equity of 20.85% evidence the strength of our combined companies post-acquisition and still include some acquisition costs. Michele will highlight a few additional adjusted ratios like the pre-tax, pre-provision earnings and our efficiency ratio later in the material. Mike Stewart will now provide color on our lines of business. His continued presence in the Michigan market with employees and customers has been valuable and I’ll just add that our 150 employees strong appreciation dinner this past Thursday was full of energy and excitement. I can’t really express just how encouraged I am by the talent of our new Level One colleagues.
Mike Stewart
Yes. Thanks, Mark.
I agree with that statement spending time in the Michigan market as I do in many markets is exciting and being able to meet our clients, work with the teammates, continue to see the opportunity is really a wonderful thing for First Merchants Bank. I have us focused on Page 7, right, business highlights.
The top of the page offers the breakdown of the core loan growth by our business units. The third quarter represented another solid quarter of working with our clients and prospects borrowing need that delivered the annualized growth rate of more than 10% excluding the PPP loans. As discussed in our prior calls, we strive for high single-digit annualized growth rates and these results achieve those targets.
As this morning’s news release noted total organic loan growth for the past 12 months has been over 13% and last quarter, the growth rate was over 20%. The commercial segment loan balances now totaled $9 billion of $11.5 billion loan portfolio, the 2.3% rate of growth for the quarter was at a slower pace than the prior quarter of 13%.
New business activity was solid as measured by new name generation but line of credit usage declined this quarter as many clients are now highly focused on loan balances given continued steep rise in interest rates, that behavior is also a primary driver of the decline in commercial deposits that you can see on the bottom section of this slide.
The commercial pipeline in the quarter at a highest level this year. We measure pipeline by both credit that is currently within our approval channel and credit within a proposal phase, both are at the highest levels.
The drivers of the commercial growth in the C&I segment continues to be the expansion of plant and equipment to meet growing demand of products and services for our clients, while line of credit utilization rates declined, our revolver commitments increased due to the continued inflationary pressures pushing up the values of working capital assets, working capital cycles on the other hand are not necessarily slower than the prior period as the supply chain issues have not been further constrained.
The second driver continues to be succession planning events within the ownership of middle market companies. Our sponsor finance team and ESOP transactions benefit from these cell site events. We have maintained a consistent and disciplined approach towards underwriting within these segments.
The last driver is the increase this quarter in investment real estate footings. Construction projects have continued to fund throughout the summer, and there have been a slower pace of project refinancing into the secondary market. Our underwriting approach has remained consistent within the primary asset classes we focus which is multifamily, industrial, warehouse, student housing, medical office, and self-storage.
Let’s move on to the consumer segment where loan growth picked up the pace in the quarter reflected by the 21% annualized growth as compared to the 14% growth year-to-date. The quarterly increases can be attributed to home equity loans, private wealth relationships, and small business activity.
The home equity activity is correlated to the continued increases in home values and our average utilization of the portfolio has remained the same through quarters. Our underwriting approach remains unchanged in all of these categories as well.
At the end of September, the consumer loan pipeline remains solid, but lower than the prior quarter. Consumer deposit balances declined for the quarter, you can see on the bottom. We have brought the former Level One franchise deposit base in align with our pricing disciplines post our integration at the end of August.
This effort is now complete and we look to drive deposit balances through our relationship model and connectivity to our whole bank efforts. The consumer team continues to gain new accounts through both in branch and digital online activities. Our investment last year in a new digital account opening process hit a high point last month with over 18% of new consumer DDA accounts being opened through the digital channel.
So let’s discuss the loan growth within the mortgage portfolio, which increased roughly $187 million in the quarter. Beyond balance sheet, residential portfolio now totaled $1.7 billion. The driver of the quarter and year-to-date increases come from continued strength in purchase volumes with more of our clients choosing five and seven year adjustable-rate product offerings. Our underwriting standards remain unchanged, prime borrowers. With the continued increases in 15 and 30 year fixed-rate options, our clients have chosen shorter-term adjustable.
Michele will review the non-interest income to tell where mortgage gain on sale remain muted as refinancing volumes are still at historical low levels. The pipeline for our mortgage team ended the quarter higher than prior year, but less than the end of June. Purchase and rehab volumes now exceed 70% of both the originated and pipeline units.
On an overall comment, the economic and business climate across all of our markets remains stable. We continue to see the resiliency in the management teams of our companies and households we serve. Our team remains responsive and ready to support our growth plans of high single-digit growth to close out the full-year 2022.
A few more comments about our expanded Michigan market and to continue Mark’s earlier statements. The Level One system integration was completed at the end of August. Our new team mates along with many legacy First Merchants folks have worked tirelessly through this change event. Collectively, they have worked with our clients and have built the foundation for future growth in Southeast Michigan, Ann Arbor, and Grand Rapids, I remain impressed and quite frankly optimistic that there is strong growth culture and demonstrated track record of winning will continue.
I’m going to turn it over to you, Michele, to provide more review of the quarter results, and we can then get to John for the soundness of our portfolio.
Michele Kawiecki
Thanks, Mike.
My comments will begin on Slide 8, covering third quarter results. You can see our balance sheet growth on lines one through five, and that we continue to trend towards a more favorable earning asset mix. Total loans on line two, which Mike covered in his remarks, increased over $290.6 million through organic growth during the quarter, which was offset by PPP loan forgiveness of $21.7 million.
Deposits decreased to $136 million during the quarter and investments on line three decreased $335 million. Liquidity from the investment portfolio funded our loan growth this quarter, as a result, our loan-to-deposit ratio continued to trend up and was approximately 81% this quarter compared to 73% in the prior quarter.
Mark covered earnings per share for the quarter in his remarks, rising yields on the loan and investment portfolios, drove higher profitability this quarter, which is reflected in the increase in net interest income on line 11 of $11.6 million.
Non-interest income also increased $1.3 million, which you can see on line 13. Non-interest expense on line 14 remains elevated, which included $3.4 million of merger costs. Our stated efficiency ratio was 53.34%, but was a low 51.39% excluding merger costs, reflecting strong operating leverage.
The tangible common equity ratio on line 6 declined 38 basis points, and the tangible book value per share on line 26 declined $1.19, as those metrics continue to be impacted by changes in the unrealized loss on the available for sale securities portfolio. Slide 9 shows our year-to-date results.
Line 25 shows year-to-date earnings per share of $2.62. Pre-tax pre-provision income year-to-date was $205.1 million, an increase of $19 million or 10% when excluding merger costs. Keep in mind that the prior year, year-to-date pre-tax pre-provision income included $27 million of PPP fee income. So, year-over-year, the core growth was exceptional.
Slide 10 shows highlights of our investment portfolio. On the bottom right you can see we had a net unrealized loss on the mark-to-market of the available for sale security portfolio of $392.5 million compared to last quarter’s loss of $246.1 million. Although the mark-to-market adjustment is meaningful. Half of our portfolio is classified as held to maturity and protects equity from the decline in value for that portion of the portfolio.
In the bottom left, you will see the cash flow we expect to receive from principal roll off totaling $260 million over the remaining months of 2022 and for the year 2023. In addition to this principle, we will also receive an additional $100 million of interest income from the portfolio, so we will have a fair amount of liquidity provided by the investment portfolio over the next 15 months without selling securities.
Slide 11 contains highlights of our loan portfolio. In the bottom-left corner, you will see the stated third quarter loan yield increased 67 basis points from 4.76% from last quarter’s yield of 4.09%. Yield on new and renewed loans increased significantly from 3.87% last quarter to 4.96% this quarter, an increase of 109 basis points.
On the bottom right, you will see $7.7 billion of loans or 66% of our portfolio are variable rate with 42% of the portfolio repricing in one month and 52% repricing in three months. So we will continue to see meaningful increases in interest income from the loan portfolio as the Fed continues to increase rates.
Slide 12 shows the details related to our allowance for credit losses on loans. We did not record any provision expense during the third quarter. The provision expense recorded year-to-date was to establish the CECL Day one allowance associated with the acquisition of Level One.
During the third quarter, we had net recoveries of 400,000, which brought the ending allowance for credit losses on loans to a robust $226.7 million. The coverage ratio trend is shown in the graph on the top left. Our coverage ratio at the end of Q3 was 1.94% down from 1.98% from prior quarter due to strong loan growth. This reserve coupled with the remaining fair value accretion of $34 million provides excellent protection as we head into an uncertain economic environment.
Now we will move to Slide 13. The total cost of deposits on the bottom chart shows deposit cost increased this quarter by 23 basis points up to a total cost of 46 basis points reflecting the strong pricing discipline we’ve had in this increasing interest rate environment. Our interest bearing deposit betas this quarter were 20%, which were flat compared to prior quarter. Competition for deposits has increased significantly and we do not expect our deposit beta to remain at the current 20% deposit beta.
Slide 14 shows the trending of our net interest margin. Line 1 shows net interest income on a fully tax equivalent basis of $146.6 million, when you back out non-core interest income items such as fair value accretion on line 2 and the impact of PPP loans shown on line 3, our core net interest income totaled $143.1 million, which is shown on line 4 compared to the prior quarter total of $130.7 million, the increase in core net interest income was $12.4 million, reflecting our higher loan yields.
Stated net interest margin on line 7, totaled 3.55% for the quarter. Adjusting for fair value accretion in the impact of PPP loans brings us to core net interest margin of 3.47% which is shown on line 10, an increase of 28 basis points from last quarter’s core NIM of 3.19%. The tax equivalent yield on earning assets increased 53 basis points and cost of funding only increased 26 basis points. We will see additional NIM expansion next quarter with the expected Fed rate increases in November and December.
On Slide 15, non-interest income totaled $29.6 million for the quarter, with the acquisition of Level One contributing a couple million of non-interest income per quarter in Q2 and Q3. Customer-related fees this quarter totaled $22.9 million, a decrease of $2.9 million from prior quarter.
The decrease in service charges on deposits reflect changes to our overdraft practices put in place mid-year. Mortgage loan production is still strong at $275 million in loans were originated this quarter, we retained approximately 75% of those loans in the portfolio and sold only 25% of them in the secondary market, causing a reduction in the gain on the sale of loans and non-interest income.
Derivative hedge fees and wealth management fees were negatively impacted by the markets. Derivative hedge fees has slowed because of the rising rate environment and wealth management fees were under pressure due to the decline in asset values. A couple of unique items that were recorded this quarter was a BOLI gain of $5.3 million, which was offset by a write-down of an equity investment of $1.9 million reflected in other income.
Moving to Slide 16. Total expenses for the quarter totaled $96.4 million which included merger costs incurred during the quarter of $3.4 million in severance of $600,000. Core compensation-related expenses reflected the impact of wage inflation. The success we’ve had filling some recent positions there are other some open positions recently and accruals for incentive.
We also incurred an increase in marketing costs as we launched ads in the Detroit market to communicate our brand. We feel confident in our ability to realize the 30% cost savings in the acquisition of Level One in the fourth quarter, but going forward, expense levels will reflect our investments in people and technology. Our low core efficiency ratio reflected in the top right shows that we continue to achieve strong operating leverage even with these investments.
Slide 17 shows our capital ratios. The decline in tangible common equity ratio over the last few quarters was due to the AOCI changes I’ve mentioned earlier on the available for sale investment portfolio and [indiscernible] $79 million in cash in the acquisition of Level One. Going forward our strong earnings and increasing net interest income will create capital and strengthen this ratio going forward.
Additionally, given we have $226 million in the allowance for credit losses, which adds to our balance sheet, safety and soundness, we feel comfortable with our current capital position. Overall, our financial results reflect strong fundamentals for the quarter and we are very pleased with the results.
That concludes my remarks. And I will now turn it over to our Chief Credit Officer, John Martin to discuss asset quality.
John Martin
Thanks, Michele, and good morning.
My remarks start on Slide 18, where I highlight the loan portfolio, including segmentation growth and composition. This quarter, I’ve included a portfolio insights slide. I will again review asset quality and the nonperforming asset roll forward before ending with a couple of high-level comments about the current environment.
Turning to Slide 18, in the quarter, excluding the $22 million reduction in PPP loans, the total loan portfolio grew $291 million or 10%, leading the growth this quarter was the addition of $191 million in residential mortgage loans with the rising interest rates, the mortgage team has leveraged the desire borrowers to take advantage of the lower adjustable rates to add high quality primarily adjustable-rate loans to the balance sheet.
While lower than the second quarter, we continue to experience broad growth in commercial Industrial loans including sponsor finance as well as in construction lending. Non-owner occupied CRE declined with borrowers moving projects to the permanent market while construction lending grew with new commitments and higher construction utilization, which climbed to 61% in the third quarter, up from 53% in the second quarter.
Turning to Slide 19, I slice the portfolio several different ways to provide additional transparency into the portfolio’s composition. Starting with C&I, this classification includes sponsor finance as well as owner-occupied CRE associated with the operating business. Our C&I portfolio is representative of our markets and thus has a concentration in manufacturing. Our current line utilization is 40% down roughly from 45% and I provided historic utilization levels to clear any confusion from prior calls.
We participate in roughly $600 million of shared national credits across various industries with an average exposure of roughly $10 million. We also have $78 million of on-balance sheet SBA guaranteed loans, which includes $11 million of remaining PPP loans.
Diving into the sponsor finance portfolio, we have roughly 60 portfolio companies, 90% of those borrowers had senior cash flow leverage less than three times and 86% had total debt-to-cash flow leverage of less than four times. 85% of those had a fixed charge coverage of greater than 1.5 times, which resulted in a current portfolio classified loan ratio of less than 3% at the end of the third quarter.
We review the individual names in this portfolio in-depth quarterly, and monitor closely for changes in asset quality. Moving to construction finance, we have a limited exposure to residential development and are primarily focused on one-to-four family non-track individual build development. Although we have a handful of residential development relationships, we continue to maintain.
For commercial construction, we continue to have a bias towards multifamily construction with a sub concentration of student housing. Moving down to consumer and residential mortgage, the portfolio consists of primarily prime-originated residential and consumer loans. These include HELOCs and HE loans, Direct Auto and miscellaneous other consumer loans.
In summary, the portfolio is a balanced mix of what one might expect from a Midwest bank with a mortgage consumer as sponsor finance and investment real estate business.
Turning to Slide 20, as in previous quarters this slide highlights our asset quality trends and current position. We continue to have favorable asset – a favorable asset quality profile with non-accrual loans online one down $2.5 million with other real estate 90 days past due and renegotiated loans, mostly unchanged.
We ended the quarter with $50.9 million in NPA’s and 90-day past due or 0.44% of loans or 29 basis points of total assets. Dropping down to classified loans in line 7 or loans with a well-defined weakness. There was a net increase of $15 million to $207 million or 1.77% of total loans, which remains comparable to pre-pandemic levels.
Then finally, we had a net recovery as Michele mentioned in the third quarter and a net recovery of $751,000 year-to-date. In the third quarter, we had a $1.3 million recovery from our 2021 charge-off related to a senior housing relationship that helped offset roughly $900,000 in charge-offs.
Then finishing up on Slide 21. We roll forward the migration of nonperforming loans charge offs ORE and 90 days past due, non-accrual loans fell $2.5 million on line 6 with the resolution of a grain marketing company from a prior period offset with the addition of a $4.7 million senior housing relationship that entered the category in the quarter. Given the current environment, we’ve been able to balance the migration of new nonperforming loans against the resolution of existing non-performing loans with $2.5 million of improvement in the quarter.
With respect to ORE and charge-off, we had nominal change in ORE with the largest bidding of 5 point. This is the largest in the portfolio being a $5.8 million student housing project with $900,000 in gross charge-offs and no other significant changes. We ended the quarter with $50.9 million of nonperforming assets and 90 days past due on line 14.
In summary, our asset quality position is strong and continues to remain stable, providing a little more color I regularly attend top borrower relationship review meetings and can see the effects from higher interest rates first-hand. While having an impact, interest rate stress built into our underwriting and the borrower’s ability to adjust either or both pricing and expenses has buffered much of the increase. We continue to closely monitor the portfolio to ensure timely issue identification and implementation of risk mitigation strategies.
I appreciate your attention. And I’ll turn the call back over to Mark.
Mark Hardwick
Thanks, John.
We followed a recommendation that Terry McEvoy had, and Terry I know you’re on the call. Thank you. I hope our analysts and investors appreciate the additional slide, that you included, John, I think that addresses some of the areas that maybe cause some cause for concern in the industry, not specifically First Merchants. In this environment, investors are always looking for more information and concerned about what they don’t know.
What we clearly believe is that we have a very balanced granular portfolio where underwriting and managing risk or they just always work in conjunction with our sales teams. We believe that our healthy level of reserves and low levels of NPAs are critical part of our strong investment thesis.
Slide 22 highlights our track record of performance. And on Slide 23, you’ll see it highlights our combined annual growth rate for assets, both organic and through M&A, which includes nine additive acquisitions, since the great recession. It’s probably a good time to talk about M&A, I’m proud of our M&A capabilities. However, I’m truly looking forward to solely focusing our teams on internal efficiencies through improved processes, procedures and technological enhancements, while strengthening the customers user experience in 2023.
Slide 24 is a reminder of our vision, our mission and the – our team statements and the strategic comparatives of the guide or decision-making. I’m confident that when you look at our results to include strong organic growth, balanced with conservative underwriting standards, healthy reserves and capital, powered by a strong operating leverage or strong pre-tax pre-provision earnings, you will see a company scorecard that aligns with its healthy culture.
We know who we are and what we stand for and our strategic imperatives drive our decision-making. Thanks for your attention and your investment in First Merchants and Michele.
We are happy to take questions at this time.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Scott Siefers with Piper Sandler. Your line is now open.
Scott Siefers
Good morning everyone, and thanks for taking the question. Either Mark and Michele is – was curious if you could address the expense topic and I think their core expense base came in higher than you guys had suggested last quarter. I certainly see the drivers in terms of marketing and compensation costs, but how much of that total level is now sticky or could it come down on a net basis, I think you guys had previously been staying closer to a like an $84 million level as the Level One cost came out, but we’re sort of a far cry from that. Now, I’m just curious to hear what the appropriate basis that we should be thinking about and where could go from here?
Michele Kawiecki
Yeah, we had some one-time items that we recorded this quarter. I highlighted a couple of those for you. And so when we look at fourth quarter expenses with inflation and some of the investments that we’ve made. We also increased minimum wage to $16 an hour. So I think fourth quarter expenses could come somewhere in the range of $89 million to $91 million.
Scott Siefers
Okay. Perfect, thank you. And then, you gave some color on NII tailwinds as we go forward. once the Fed stops raising rates, we’ll certainly have the cash flows from the securities portfolio, but of course, presumably deposit betas will begin to catch up, what’s your confidence in First Merchants’ ability to continue to grow NII sequentially once the Fed stops raising rates?
Michele Kawiecki
We’ve got a pretty significant portion of our variable-rate loans that reprice in the first year. So even once the Fed stops raising rates, we will see lift in interest income over the course of the year. The deposit competition and how quickly betas rise, that remains to be seen. I do think that we’ll see deposit betas get back to historical levels through the cycle, but we do think that we’ll see net interest margin lift over the next couple of quarters.
Mark Hardwick
Yes, Scott. And we’ve always been confident that even when the Fed stops that our organic growth rates continue to remain strong and helped us power through in terms of earnings.
Operator
Please standby for our next question. Our next question comes from Daniel Tamayo with Raymond James. Your line is now open.
Daniel Tamayo
Thank you and good morning everyone. We could talk a little bit about the fee income outlook, you touched on the overdraft impact in deposit service charge obviously mortgage banking has come down. And then you talked about the amount being sold in the market relative to what you’re keeping you’ve seen some nice resi growth there on the balance sheet. But overall, kind of the number looked a little bit lighter than I was expecting. I guess pulling out the BOLI gain in the corresponding hit there, but how are you thinking about where fee income could shake out here in the fourth?
Mark Hardwick
I think these are our levels that you can anticipate going forward. And we’ve always viewed our noninterest income to be driven off of our – off of our core customer base, but it’s also always been a real hedge in terms of just interest rates and when rates rise our noninterest income typically isn’t as strong and when rates start to go the other direction, our fee income helps, pick us up. So these levels were not excited about where we are today, but it is consistent with what we expect when you have the rising rate environment.
Daniel Tamayo
Okay. Thanks, Mark. And then I think you just mentioned that you’re continuing to expect pretty good growth. I think that was meant on the loan side, but maybe just kind of talk a little bit about what you’re seeing, what you’re expecting on the loan growth side. I’m assuming that the residential mortgage growth will slow here with rates up and perhaps selling a little bit more of that production. But what curious where you’re seeing the growth on the loan side, and what kind of growth you’re expecting is maybe demand slows with rates being up here.
Mark Hardwick
Yeah, I’ll just say that our guidance of mid to high single digits is always the objective. We’ve had a little stronger year, this year because of the mortgage activity, and our willingness to use our balance sheet. We’re actively looking for additional sources to sell the five and seven-year ARMs because there’s only so much balance sheet capacity, we can commit to mortgage.
So it’s been a really nice add to our growth in 2022. I don’t see it continuing at the same level. Although I do feel great about our production and the quality of the team. We’re looking for secondary source to sell into the market. The real core of our growth is going to come out of the commercial balance sheet and Mike mentioned our pipeline, I’ll let him maybe touch on some of the areas where you feel is best.
Mike Stewart
Yes, I did highlight briefly, Daniel that our commercial pipeline at the end of the quarter is really strong and if you watches over time you can see that kind of predicting that the outlook quarter-to-quarter can be a little bit choppy. But when you look at it over continue with time that’s why I feel always confident about that high single-digit.
We had a really strong second quarter and we had a good third quarter here, but the pipeline makes me feel like the fourth quarter will finish out strong and it’s due to I think some of those things I was trying to highlight which is businesses are finishing their capital plans preparing themselves for 2023 they are preparing for the continued working capital increases that they still see coming down the pipeline, and now we’ve got a broader market as you know in the Greater Michigan marketplace that we haven’t really fully penetrated yet. So I do think that the C&I, real estate, commercial will be the continued driver of our balance sheet it’s the biggest part of it as well.
Daniel Tamayo
Okay, thank you. That’s helpful. And then lastly, I guess just kind of following up on the NII growth question earlier, but looking at it from a different perspective. You talked about cash flow securities funding loan growth to a large extent in the third quarter and still having an ability to do that going forward. How are you thinking about the willingness ability to be able to do that, and then as it relates to the growth of the overall balance sheet, what are you expecting there?
Mike Stewart
Yes. And this chart fully follow, I think you’re just talking about capacity to fund, is that where you’re going, Daniel?
Daniel Tamayo
So essentially like if you’re going to be remixing continue to remix the balance sheet from funding loan growth from security maturities if the balance sheet is expected to remain relatively stable going forward.
Mike Stewart
Oh, yes.
Michele Kawiecki
I think our balance sheet will continue to grow the securities balances they will decline some as we cash flow that portfolio, but I think the loan growth as Stew said will be in the mid to high single digits. And so that will drive balance sheet growth overall.
Mike Stewart
And we are expecting loan-to-asset ratios to increase as well longer deposit ratios.
Operator
Please standby for next question. Our next question comes from Damon DelMonte with KBW. Your line is now open.
Damon DelMonte
Hi, good morning everyone. Hope you guys are doing well today. So my first question just on the outlook for the provision, I know you guys have been kind of growing into your reserve levels over the last few quarters and not in booking reserves. Just kind of with the growing concern for deterioration with the broader economic outlook. Could you just kind of give a little update as to where you think a reasonable reserve level would be to settle in it?
Michele Kawiecki
Yeah, our reserve levels are still pretty robust. And so we feel like we’ve got great coverage heading into this uncertain economic environment, for kind of whatever it brings our way. So I’m not expecting to need to take any additional provision over the coming quarters. I think that we’ve got, I think we’ve just got ample coverage today.
Damon DelMonte
Okay, that’s great. And are there any like segments of the economy or areas in the portfolio where you’re kind of pulled back a little bit out of concern of storm clouds on the horizon.
Mark Hardwick
Yeah, I would answer, Damon, not really, no. The higher interest rates have economic impacts to projects in the borrowers may have less demand going forward. But from our willingness Stew mentioned it earlier is that consistency of underwriting so it’s not that we’re pulling back. It’s just where there is demand and the portfolio given the static underwriting.
Damon DelMonte
Got it. Okay, that’s helpful. And then I guess lastly, just to kind of circle back on the margin. I appreciate the commentary and color on the outlook, but just wondering from a cadence standpoint, Michele, pretty sizable increase this quarter I think was like 27 basis points linked quarter, how do you feel that upward trajectory goes over the upcoming quarters. Do you think you could repeat something like this level, or do you think you kind of starts to moderate?
Michele Kawiecki
Yeah, I think it will moderate our deposit beta was only 20% this quarter. And I do think that will creep up, as the competition for deposits grows. I would think and if we assume a 75 basis point increase in November, and another 50 in December, we think we will be at another 15 basis points of margin lift assuming and that assumes that our deposit betas start to increase a bit. And then maybe another 10 in Q1, another 10 basis points lift in NIM in Q1.
Operator
Please standby for next question. Our next question comes from Terry McEvoy with Stephens. Your line is now open.
Unidentified Analyst
Good morning. This is [indiscernible] for Terry. I have one question most of the other ones have been answered already, but pertaining to capital CET1 is about 10.4% this quarter, can you talk about your thoughts on capital management and potential opportunity for share repurchases going forward?
Michele Kawiecki
Yes. Our capital levels right now and we’re really pleased with where we’re at and then we don’t anticipate doing share repurchases in the coming quarters.
Operator
Please standby for the next question. Our next question comes from Brian Martin with Janney. Your line is now open.
Brian Martin
Hi, good morning. Just wanted to touch base just a couple, kind of housekeeping questions, just as far as the deposit growth, or just the shrinkage this quarter, just given the environment out there, just kind of wondering your outlook on the deposit side. And just how you’re seeing, what you’re hearing from your customers, and the expectation for growth there, prospectively just more stable. Just how you’re thinking about that?
Mark Hardwick
Yes. We expected little bit more of a stable environment. I mean we’d love to see some growth just out pure activity. All the work that we’re doing. But the interest rate environment and our management of that costs are they hold growth back some, but and we just think it’s a nice balance between making sure that we’re not overpaying, and that we’re still adding relationships, which the teams are doing every day.
Brian Martin
Got you. Okay. And then maybe just on the deposit side. Michele. I think you said you’re kind of 20 now just as kind of where you’re thinking that heads to if you get, kind of increases you outlined there may be a 75 and 50, you get into next year just later this year that deposit beta. What would you expect that kind of creeping up to?
Michele Kawiecki
In this last cycle, we had deposit beta of 41% and I think through the cycle by the time we get to the end of the cycle, we’ll probably hit that deposit beta again but how quickly it rises that just kind of remains to be seen with competition for the NIM over the next quarter two, we’ve been modeling a 25% deposit beta so up about 5% from where we’re at today.
Brian Martin
Got you. Okay. Now, that’s helpful. And just see maybe two last ones, just on the – the utilization was a little bit lower this quarter, is there any just lumpiness in that, is that how to read that. I mean, the trends had been a little bit different, but just want to see if there’s anything it would easily explainable or is it just going to be a little lumpy, is that how you guys would think about it?
Mark Hardwick
There are two things, and then Stew got some thoughts I would say that the first thing is that Level 1 had a 34% utilization rate. And when those commitments were added in the third quarter to our reporting databases that it drove down from 44% to 40%, so a little bit that showed in the quarter, it’s just as well as just paydowns from the balances for people holding cash.
They find it favorable to pay down their lines over keeping cash in their checking account. So a couple of factors there that I think contributed to lower utilization.
Mike Stewart
And even the legacy First Merchants portfolio utilization went down very little but it went down, just kind of interesting phenomenon, to say the least. Really, and I just attribute that to we got really smart business owners that know how to manage working capital cycles. They are keeping their working capital to a really good pace. When you think about the growth that’s happening with the inflationary pressures that go that drive up inventory that didn’t drive up their receivables.
But yet, they still have ample liquidity. Before that, we’re not seeing slowness in account receivable collections. We’re not seeing still inventory. So it’s really, it’s to me just another observation of a pretty strong business community.
Brian Martin
That’s helpful, Mike. And then maybe just one last one was just on the tax rate, just how to think about the tax rate next quarter kind of next year. It seems like there’s a little bit lower than I thought this quarter, maybe I was incorrect in that. But just how to think about that?
Michele Kawiecki
Yes. The tax rate was a little lower this quarter because of the BOLI gain that’s tax exempt. And so I would say an effective tax rate going forward to be about maybe 14.5%.
Operator
At this time there are no other questions. I would now like to turn the conference back to Mark K. Hardwick for closing remarks.
Mark Hardwick
Thank you, Michelle. Thanks to all our participants for joining the call. We had a great quarter. We’re really excited about what the future holds. And just look forward to your continued investment. Thank you.
Operator
This concludes today’s conference call. Thank you for participating. You may now disconnect.
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