First Merchants Corporation (NASDAQ:FRME) Q4 2022 Earnings Conference Call January 26, 2023 10:30 AM ET
Company Participants
Mark Hardwick – Chief Executive Officer
Mike Stewart – President
John Martin – Chief Credit Officer
Michele Kawiecki – Chief Financial Officer
Conference Call Participants
Scott Siefers – Piper
Daniel Tamayo – Raymond James
Terry McEvoy – Stephens
Damon DelMonte – KBW
Brian Martin – Janney
Operator
Good day and thank you for standing by. Welcome to the First Merchants Corporation Fourth Quarter Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that this conference call 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 reconciliation of GAAP to non-GAAP measures.
I would now like to turn the call over to Mark Hardwick, CEO. Please go ahead.
Mark Hardwick
Well, good morning, and welcome to the First Merchants’ fourth quarter 2022 conference call. Lisa, thanks for the introduction and for covering the forward-looking statement on Page 2. We released earnings today at approximately 8:00 a.m. Eastern time. You can access today’s slide 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. I’m excited to share our results with you today, given our strong performance in 2022 to include a clean fourth quarter that requires no adjustments related to our April 1st acquisition of Level One. Our message should reflect my appreciation towards our clients and our teammates for delivering a very good year. We also hope to establish a baseline through our Q4 results that allows for effective modeling around an optimistic 2023 inclusive of the realism required given the industry headwinds.
Now, if you turn to Slide 5, net income totaled $70.3 million for the quarter compared to $47.7 million in the fourth quarter of 2021. Reported EPS for the fourth quarter totaled $1.19 without any required adjustments compared to Q4 2021 of $0.89, a 33% increase. Organic growth in loans of 11.8% for the quarter and another 18 basis points of core margin expansion over Q3 of 2022 by the drivers of our EPS improvements. This performance resulted in a 1.59% return on assets and a 24.2% return on tangible common equity for the quarter. The year-to-date results, our EPS totaled $3.81, which equaled last year’s total of $3.81. However, this year’s results had $27.7 million less PPP income than last year and $33.3 million more acquisition expense than last year’s earnings per share.
When adjusted for those two items, which totaled $60 million, our year-to-date 2022 EPS totaled $4.20, which is 24.3% better than 2021’s total of $3.38. Fueling the improvements for the full year for once again loan growth, excluding our acquisition totaling 13.9% and core net interest margin expansion of 34 basis points. Mike, Michele, and John will provide some color on the loan portfolio, its makeup, pricing and areas of growth later in the presentation.
Now Mike will cover Pages 6 and 7.
Mike Stewart
Yes, thank you, Mark, and good morning to all. As you look at the next two slides, I will provide an update on our line of business results and their contributions within the quarter. Since our business strategy on Page 6 remains unchanged, I want to focus on Page 7 titled business highlights. The top of the page offers a breakdown of the core loan growth by our business units. The fourth quarter represented another excellent quarter of organic growth, nearly 12% in aggregate with the commercial segment growing over 10.5%. The results continue to demonstrate the close working relationship between our team and our markets. As discussed in prior calls, we strive for high single digit growth rates, and as noted on the right hand side of this chart, we achieved those levels for all of 2022, the commercial segment over 8.5%, the consumer segment over 9.5%, the mortgage segment close to 60%. As footnoted, these are organic results adjusted for PPP and the day one balances of the Level One acquisition.
But I do want to spend more time on the global loan results, specifically the dollar increases behind the percentages on this page. As noted on Slide 11, the commercial segment represents 75% of our total loan portfolio. The 10.6% fourth quarter growth rate in commercial was approximately $240 million or 70% of the total fourth quarter loan growth of $345 million. While the consumer segment contracted this quarter by 3.1%, that dollar amount is less than $7 million. The mortgage portfolio growth during the quarter was approximately $100 million versus the prior quarter growth of $190 million. My point is the commercial segment continued to be the loan growth engine of the bank. All segments can demonstrate solid growth rates and John Martin is going to talk more about the detail of our portfolio later in the presentation.
Let me go into the drivers of commercial loan growth in the fourth quarter. There are threefold. New business activities, first and foremost our teams continue to win new relationships across the geographies and across all segments of focus. Our team alignment puts them in the best position to win. We have alignment with our credit partners and we have alignment on market coverage. I shared several quarters ago we added key staff within certain markets to augment our existing teams. This people investment was within asset-based lending, upper middle market, and syndications, and all are contributing alongside our existing team. The second driver of growth was from our existing clients, capital for expanded plant and equipment, working capital growth and acquisition financing remained active through the end of the year. And the final driver is line utilization specifically within investment real estate, which is construction draws and the C&I line utilization inched up 1%. Overall, we have maintained a consistent and disciplined approach towards underwriting within all these segments and the commercial pipeline ended the quarter consistent to prior quarters.
Moving on to the consumer segment, loan balance is contracted by 3%. As the second bullet point notes, the $7 million decline is attributed to the private banking footings. With the rise in interest rate, certain clients reduce balances with excess investments or lower earning deposits. On the contrary, home equity balances continue to increase during the quarter, which is correlated with increasing home values. Average utilization on that portfolio has not changed. And across all of consumer, our underwriting approach remains unchanged. Additionally, the consumer loan pipeline remains consistent with prior quarters.
So let me touch on the mortgage segment. The 24.2% growth rate was approximately $100 million. The aggregate mortgage portfolio is now just over $1.8 billion, or 15% of the total $12 billion loan portfolio, again trying to highlight the emphasis on commercial. The driver of the quarter and year-to-date increases in mortgage comes from the continued strength and purchase volumes with more of our clients choosing our five and seven year adjustable rate product offerings. Our underwriting standards remain unchanged here prime borrowers. With how low housing inventory, high home prices and higher mortgage rates, the mortgage pipeline ended lower for the fifth consecutive quarter.
I want to speak to the deposit section on the bottom half of this page. We are actively managing the deposit rates to maximize our margin. The quarterly decline of 1.4% continues an improving trend. Last quarter we reported 3.7% deposit contraction, which was less than the 8.2% deposit contraction reported in the second quarter. Consumer deposit balances increased for the quarter at a 4.1% annualized rate. The consumer team continued to gain new accounts through both in branch and digital online activities. Additionally, our consumer relationships have responded favorably to our new money CD and new money market promotions. As noted in the first bullet point, the commercial deposit decline is primarily from the public fund sector. The decline in this segment is simply from municipalities or school corporation looking for the highest marginal deposit rates across the competitive landscape. Additionally, many business clients continue to utilize excess liquidity on their balance sheets for higher returning activities like acquisitions, plant expansions or dividends.
Michele has more details to share about our balance sheet, our expanding margin along with greater details of our other key performance metrics. Michele?
Michele Kawiecki
Thank you, Mike. My comments will begin on Slide 8, covering fourth quarter results. You can see on our balance sheet on lines one through five that we continue our trends towards a more favorable earning asset mix. Total loans on line 2, which Mike covered in his remarks, increased $344.1 million, or 11.8% through organic growth during the quarter, which was offset by PPP loan forgiveness of $6.5 million to arrive at the $337.6 million you see in the variance column. Deposits decreased $52.1 million during the quarter and investments on line 3 decreased $31 million. I will add some additional color on our investment balance later in my comments. Our loan-to-deposit ratio continued to trend up and was approximately 83.5% this quarter compared to 81% on a linked quarter basis, and 72.7% in prior year.
Earnings per share for the quarter totaled $1.19, which reflects our bank’s strong performance. Pre-tax pre-provision earnings totaled $83.8 million this quarter, a 9% increase over last quarter when excluding acquisition costs. Rising yields on earning assets offset somewhat by higher deposit costs drove higher profitability this quarter, which is reflected in the increase in net interest income on Line 11 of $8.6 million over prior quarter.
Non-interest income on Line 14 declined by $5.5 million due to a large BOLI gain recorded in the third quarter. Adding to the quarter-over-quarter profitability was lower non-interest expense, which declined $6.7 million, bringing our net income on Line 17 to $70.8 million, an increase of nearly $7 million over Q3 or 11%.
Our stated efficiency ratio was 48.6%, but excluding the lingering acquisition costs of $400,000 that was recorded in the fourth quarter, the efficiency ratio was 48.37%, reflecting excellent operating leverage. The tangible common equity ratio on Line 6 increased 68 basis points. Intangible book value per share on Line 26 increased $2.19 or 11% reflecting the strong earnings from the quarter as well as a meaningful recovery in the unrealized loss valuation of the available for sales securities portfolio.
Slide 9 shows our year-to-date results. Line 25 shows year-to-date earnings per share of $3.81, which on a stated basis equals earnings per share for 2021. As Mark mentioned, non-recurring items had a meaningful impact on earnings. So when excluding acquisition costs, Day 1 CECL provision and PPP loan income, EPS for 2022 totaled $4.20 and 2021 totaled $3.38 for an increase of 24% reflecting strong core organic growth and profitability and the contributions of the Level One acquisition.
Pre-tax pre-provision income year-to-date was $289 million, an increase of $47.6 million or 20% over prior year. Keep in mind that the prior year pre-tax provision income included $31 million of PPP fee income compared to just $3.2 million in 2022, so year-over-year the core growth in PPP fee was significant.
Slide 10 shows highlights from our investment portfolio. On the top right, you can see the yield on the portfolio remains stable given we aren’t reinvesting in bonds, although the total portfolio balance only declined $31 million from last quarter, the portfolio actually declined $130 million from pay downs, maturities, and sales of bonds. Bond sales during the quarter totaled $82 million, which netted to a very small gain of less than $100,000.
As our portfolio manager continues to find opportunities to sell bonds without realizing any meaningful losses, this $130 million decline was offset by an increase in the valuation of our bond portfolio of $96 million. On the bottom right, you can see we had a net unrealized loss on the mark-to-market of the available for sales securities portfolio of $296.7 million at year-end, which compared to $392.5 million in Q3, which reflected a nice recovery.
On the bottom left, you will see the cash flow we expect to receive in 2023 of $360 million, which includes cash from principal and interest payments, maturities and expected bond sales. The bond portfolio will continue to be a strong source of liquidity to fund our loan growth through the year. Slide 11 contains the highlights of our loan portfolio.
In the bottom left corner, you will see the stated fourth quarter loan yield, increasing substantially up to 82 basis to 5.58% from last quarter’s yield of 4.76%. On the top right, I noted the yield on new and renewed loans, which also increased significantly from 4.96% last quarter, up to 6.10% this quarter, an increase of 114 basis points.
On the bottom right, you will see 8 billion of loans or 67% of our portfolio are variable rate with 40% of the portfolio repricing in one month and 50% 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 fourth quarter. As a reminder, the provision expense recorded year-to-date was to establish the Day 1 CECL allowance associated with the acquisition of Level One.
During the fourth quarter, we had net charge offs of $3.4 million, which brought the ending allowance for credit losses on loans to $223.3 million. The coverage ratio trend is shown in the graph on the top left. Our coverage ratio at the end of Q4 is 1.86%, down from 1.94% at the end of Q3 due to strong loan growth. This reserve coupled with the remaining fair value accretion of $31 million, which gives us some additional coverage for acquired loans, provides great credit protection given the uncertainty of the economic environment.
Now, I will move on to Slide 13. The total cost of deposits in the bottom chart shows costs increased by 46 basis points up to a total cost of 92 basis points reflecting the competitive pricing environment. Our interest-bearing deposit cycle to-date beta at year-end was 29%, which was up from 20% last quarter. Competition for deposits continues to increase and we expect our deposit beta to increase in response.
Slide 14 shows the trending of our net interest margin. Line 1 shows net interest income on a fully tax equivalent basis of $155.3 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 $152.5 million, which is shown on Line 4. Compared to the prior quarter total of $143.1 million, the increase in core net interest income was $9.4 million, reflecting our higher loan yields.
Stated net interest margin on Line 7 totaled 3.72% for the quarter. Adjusting for fair value accretion and the impact of PPP loans brings us to a core net interest margin of 3.65%, which is shown on Line 10, which is an increase of 18 basis points from last quarter’s core NIM of 3.47%. The tax equivalent yield on earning assets increased 62 basis points and cost of funding only increased 45 basis points.
On Slide 15, non-interest income totaled $24.1 million for the quarter, which was down $5.5 million from last quarter. Recall that we recorded a $5.3 million BOLI gain in the third quarter that elevated our total non-interest income in Q3. Customer-related fees this quarter totaled $21.9 million, which was relatively stable in all categories from prior quarter.
Although, gains on the sale of mortgage loans remained at a modest level this quarter, mortgage loan production is still strong despite fourth quarter lower seasonal purchase trends as $217 million in loans were originated this quarter. We retained approximately 80% to 85% of these loans in the portfolio and sold the remainder in the secondary market.
Moving to Slide 16, total expenses for the quarter totaled $89.7 million. Q4 included just $400,000 of lingering acquisition costs. So this is our first quarter with a normalized expense run rate and reflects the achievement of our cost savings goals associated with the acquisition of Level One. This was $6.7 million lower than third quarter as third quarter included $4 million of acquisition and severance costs.
Core compensation related expenses were a bit lower than last quarter as we refined our incentive accruals and we recorded 700,000 of gains on sales of property, which offset expenses. Our low core efficiency ratio reflected on the top right shows that we continue to achieve strong operating leverage even while we invest in technology and talent to grow the business.
Slide 17 shows our capital ratios, although the tangible common equity ratio remains below our target, we saw great improvement this quarter. The declines in tangible common equity that occurred during the year were due to accumulated other comprehensive income changes from the market valuation of the available for sale investment portfolio and the use of cash in the acquisition of Level One.
As I mentioned earlier, we recovered $96 million in other comprehensive income from the bond portfolio valuation this quarter. That along with strong organic earnings created nice capital build. Considering these capital levels, along with $223 million in allowance for credit losses, we feel great about the safety and soundness of our balance sheet moving into 2023. Overall, our financial results were exceptionally strong this quarter and for the year 2022, reflecting the hard work and dedication of our First Merchants’ teammates.
That concludes my remarks and I will now turn it over to our Chief Credit Officer, John Martin to discuss asset quality.
John Martin
All right, excuse me. Thanks Michele and good morning. My remarks start on Slide 18 where I highlight the loan portfolio including segmentation, growth and composition. I’ll comment on the updated portfolio inside slide then review asset quality and the non-performing asset roll forward before ending with a couple of high level comments on the environment.
So turning to Slide 18, in the quarter, we experienced strong commercial loan growth, as Stu mentioned a moment ago, originated by our middle market lending team, which for us, our companies with revenue generally between $10 million and $500 million. Within the space, the greatest growth occurred in the manufacturing and wholesale trade sectors.
Investment real estate increased $108 million on Line 5, bringing our balances back closer to where they were in the second quarter. And finally, we moderated the pace of portfolio, residential mortgage growth as we shifted back to a more originate and sell model, adding $89 million after several very strong quarters of portfolio growth.
So after a quarter of 11.8% loan growth and combined annual organic loan growth of 13.9% or $1.3 billion for the year, the composition between C&I, non-owner occupied CRE and investment – excuse me, and residential mortgage loans remains in balance and substantially similar to what it was at the beginning of the year.
So turning to Slide 19, I’ve updated the portfolio insight slide here where we slice the portfolio several different ways to provide additional transparency into its composition. Starting with C&I, the classification here includes sponsor finance as well as other – excuse me, as well as other owner-occupied CRE associated with the business. Our C&I portfolio is representative of our markets and thus has a concentration in manufacturing of 18% of the portfolio. Our current line utilization as Stu mentioned a moment ago, remained relatively stable at 41% up from roughly 40.2%, and I’ve provided historical utilization levels for reference.
We participate in roughly $700 million of shared national credit balances across various industries with an average exposure of roughly $10 million. We also have $70 million of SBA guaranteed loans which includes $5 million of remaining PPP loans.
Diving into the sponsor finance portfolio. There are 65 relationships roughly with 76% of the borrowers having a senior cash flow leverage of less than 3x and 79% having a total debt to cash flow leverage of less than 4x. 76% had a fixed charge coverage ratio of greater than 1.5x, which resulted in a current portfolio classified loan ratio of only 4.2%. We review the individual names in this portfolio quarterly for changes, including leverage, cash flow and borrower condition.
Moving to construction finance. We have limited exposure to residential development and are primarily focused on one to four family non-track individual build residential construction loans, too mouthful. For commercial constructions, we continue to have a bias towards multi-family 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 HELOC and HE loans and to a much lesser extent, branch originated auto secured and miscellaneous other consumer loans. In summary, the portfolio is a balanced mix of what one might expect from a Midwest bank with mortgage, consumer sponsored finance and investment real estate businesses.
Turning to Slide 20. As in previous quarters, this slide highlights our asset quality trends and current position. We continue to have a favorable asset quality profile with non-performing loans on line six at 42 basis points of loans down from 44 basis points to the prior quarter. Classified loans on line seven or those loans with a well-defined weakness increased roughly $8 million to $215 million or 1.79% of loans, which remains comparable to pre-pandemic levels.
Then finally, we had net charge-offs of $3.4 million in the quarter. In the fourth quarter, we had a single borrower charge-off of $2.8 million related to a third quarter 2021 non-accrual loan. While we continued to pursue potential recovery strategies, the account is now fully charged-off.
Then finishing up on Slide 21 where we roll forward the migration of non-performing loans, charge-offs, ORE and 90 days past due. For the quarter non-accrual loans were down $1.2 million on line six with the charge-off just mentioned and the resolution of $4.8 million of other non-accruals this quarter. This included the demonstrated performance and consistent payments from a prior year non-accrual account in the amount of $1.2 million and the resolution of various other non-accrual accounts all under $500,000 individually.
Given the continued strong environment, we’ve been able to balance the migration of new non-performing loans against the resolution of existing non-performing loans making $200,000 of improvement in the quarter on line 13 and only an increase of $5.8 million for the year after we added $9.4 million of Level 1 non-accrual loads.
So overall borrow results have continued to remain stable despite higher prices and interest rates. I would say that while higher interest rates have had an impact, interest rate stress is built into our underwriting and the borrowers ability to adopt – excuse me, adjust either or bulk pricing and expenses has thus far buffered much of the impact.
As one might expect, it is the financially weakest customers, consumers and commercial borrowers who are being affected most, and as always, we mitigate the environment by making sure we continue to monitor the portfolio for timely issue identification and the implementation of risk mitigation strategies.
I appreciate your attention. I’ll turn the call back over to Mark for his remarks.
Mark Hardwick
Well, thanks John. Slide 22, you can see we made some adjustments to the CAGRs. We’re just looking back 10 years, probably a more relevant post-recession timeframe, which reflects really strong performance as evidenced by a number of the graphs. You can see earnings per share. The CAGR during that period is 10.5%. Adjusted CAGR for the AOCI on tangible book value per share is 9.3% and the return on tangible common equity across the board in the double digits.
If you turn to Slide 23, again, we adjusted for 10 year timeframe. In our 10 year asset CAGR, which does include acquisitions as 15.3% inclusive of the eight acquisitions you see over to the right. Shelby County was included in the year end $4.3 billion. So strong growth and the best thing about our growth rate and moving from $4 billion to $18 billion, we love the fact that we have the ability to take care of more customers with a larger balance sheet. I think we’re an even greater attraction point for talent and there’s opportunity for growth in this company. We’re a growing organization and we continue to create new and unique ways for people to expand their career. It’s been fun.
If you look on the next Slide 24, it’s just a reminder of the vision, the mission statements, our team statement and our strategic imperatives of which we use to guide our decision making. Lisa, we’re happy to take questions at this time and just thank everyone for their attention.
Question-and-Answer Session
Operator
Okay. Thank you. [Operator Instructions] The first question I have is coming from Scott Siefers of Piper. Please go ahead. Your line is open.
Scott Siefers
Good morning, everyone. Thank you for taking the question. Just the first question was on expectations around the margin. Maybe Michele just thoughts on where we go from here. Maybe best to think about it in terms of the 365 core margin, I guess. And then as a follow on more broadly on NII, do you feel like you can continue to grow NII sequentially from here as we look throughout 2023?
Michele Kawiecki
Yes. Good morning, Scott. I think looking at net interest margin, particularly for Q1, we have assumed that we get two additional 25 basis point increases, one in February and one in March. And so looking for Q1, I think we would expect to see another 6 or so basis points of net interest margin growth. You had mentioned, looking at a 360, the one thing that I do want to remind everybody of is that given there are a couple less days in Q1, there’s always a seasonal headwind on margin for us given our commercial orientation. And so that always ends up reducing our margin a few basis points. And so we would still expect to see net interest margin increase, even netting that impact out of a few basis points in Q1.
Scott Siefers
Perfect. Thank you. And then your thoughts on the ability – the company’s ability to continue to grow NII sequentially. I imagine at least with some margin expansion that should give you a little lift, but just overall thoughts would be welcome.
Michele Kawiecki
Yes, sure. So for our net interest income for Q4, looking at like $149 million stated, $155 million on a fully tax equivalent basis, I would expect Q4 2023 net interest income to be a good run rate on average for 2023. We revisited our deposit beta assumptions and as a reminder, our historical deposit beta was 41%. Our assumption is that we will get up to a 40% deposit beta in Q1 and get up to 50% deposit betas later in the year. And so we’re being fairly conservative, I think in our outlook, but we think that it is going to be competitive and we want to be prepared for it.
Scott Siefers
Okay, perfect. And just to make sure I heard correctly, so it sounds like what you just posted the fourth quarter 2022 NII, we should sort of average that for 2023, and that’s where you think things will flush out?
Michele Kawiecki
Yes, that’s correct. I mean, I do think we will see net interest margin compression later in the year because of the deposit betas increasing, but I think we can offset that with our loan growth.
Scott Siefers
Perfect. Okay, wonderful. Thank you very much.
Operator
Thank you. One moment while we prepare for the next question. The next question is coming from Daniel Tamayo of – excuse me, Raymond James. I’m sorry.
Daniel Tamayo
Thank you. Good morning, everyone. Maybe just following on the net interest income discussion and the expectation that we may get a decline in rates at some point possibly at the end of the year. Have you been making any changes to the sensitivity of the balance sheet to present perhaps mitigate that? Or is the asset sensitivity kind of the same as or similar to what it’s been prior?
Mark Hardwick
Yes. We’re not making any real – any, I guess, meaningful change. We continue to look at protections in the bond portfolio against future falling interest rates, but more of the liquidity to fund loans. There’s not a lot of flexibility to make adjustments. If we didn’t need that liquidity, you could probably move in and out of some sectors and make some changes. But we feel like we have a model that works in both interest rate environments. And as we’ve assessed things like macro hedges, et cetera, the cost just seems prohibitive to us.
Daniel Tamayo
Understood. Yes. And then I guess just switching gears here to reserves. Obviously you’ve been having a provision of zero here for quite a while now. Just interested in your thoughts on when you think you may have to start providing for loan growth or maybe where that reserve ratio stabilizes here?
Michele Kawiecki
Yeah. We don’t expect to have to take provision in the near-term. We are modeling a mild recession in our CECL models currently. But each quarter will continue to evaluate coverage with our loan growth, and particularly if we see any credit events occurred during the quarter, but no plans in the near-term.
Daniel Tamayo
Okay. Thanks, Michele. I’ll step back. Thanks for answering my question.
Mark Hardwick
Thanks, Daniel.
Operator
Thank you. One moment while we prepare for the next question. The next question is coming from Terry McEvoy of Stephens. Your line is open.
Terry McEvoy
Hi. Thanks. Good morning, everyone.
Mark Hardwick
Good morning, Terry.
Terry McEvoy
Hi. Maybe just start with your outlook for expenses as you think about overall wage inflation and then the uptick in FDIC costs as well.
Michele Kawiecki
Yes, I’d be happy to. Using the Q4 stated expense level as a base, we would expect probably mid-single digit growth and expenses, say 5% or 6%. I think that would accurately capture the inflation that we’re all experiencing and also some investments in technology and people as well as that FDIC increase that you mentioned.
Terry McEvoy
Okay. And any comments on banker or customer attention at level?
Mike Stewart
Mike Stewart here. I’d say overall it’s been pretty stable. Banker stability, there’s been some moving in, some moving out. Banking stability, we’re starting to see new business activities in some of the portfolios. So I call it overall pretty stable meaning, or I’ll interpret it, Mike Stewart’s way, which is kind of where I would expect to be less than two quarters posting integration with an outlook that I think we’re in a good position to take advantage of.
Terry McEvoy
Maybe one more, if I could squeeze it in. Mark, your comment in the press release caught my eye that the earnings power is pretty easy to digest when you look at the quarterly results. And as a former CFO, I can ask you the question, what exactly really stands out to you as being that kind of source of power. There’s a lot of things that go into earnings power, and we’d love to just get your view as we kind of think about 2023?
Mark Hardwick
Yes, happy to do it. I was really pleased to have – I would look forward to. I guess I should say, and I was pleased by this quarter’s result where we have fully digested our last acquisition. And I think you can see the earnings power in our numbers and really it’s just the fact that historically, I mean, we have guidance of mid to high single digit growth rate. And I feel like we always achieved those objectives. And you can go back a number of years and we’ve had good success. I love the team that we have in place. I love how hard they work and the impact they try to make with our customers.
I think our balance sheet is well hedged. I didn’t mention if rates come down, we end up just with a nice natural hedge with our mortgage portfolio a little bit with our derivatives, the loan level hedges that we sell to our customers. So I look at our income statement and our balance sheet. I think we have a growing balance sheet on the asset side. We have an awesome core deposit base on the consumer side. I feel like our margins are fairly easy to understand and fairly predictable.
And I feel like even though we’re investing in the business, which is exciting to everyone here, we continue to add talent. We continue to invest in technology that we’re able to do in a way that still produces a 50, a low 50s efficiency ratio. And this quarter was 48%. So, there are always headwinds in the business or tailwinds, and they migrate back and forth and my view is this is a bank that has consistent performance over time. And some of those things are a little bit like the weather. You wake up and see, is it snowing? Is it raining? Is the sun out? But I’ll tell you what everybody on our team, they get after it regardless of what the day looks like. And so I just feel like we have a team that works hard, produces results, and it’s pretty easy to see I think in our financials, especially in a quarter like Q4.
Terry McEvoy
Appreciate that. Thanks, everyone. Have a nice day.
Michele Kawiecki
Thanks, Terry.
Mark Hardwick
Thanks, Terry.
Operator
Thank you. One moment while we prepare for the next question. Our next question comes from Damon DelMonte of KBW. Your line is open.
Damon DelMonte
Hey, good morning, everyone. Hope you’re all doing well today.
Michele Kawiecki
Good morning, Damon.
Damon DelMonte
Just wanted to – good morning. Just wanted to circle back on the provision outlook commentary, Michele. Obviously, the reserve is quite healthy and you guys have been quite clear on your desire to kind of grow into a normalized reserve level. If you could ballpark that like ultimate level that would – that might be helpful. Is there a way you could kind of quantify that?
Michele Kawiecki
Well, I think that what I do is probably go back and think about like our Day 1 CECL adjustment that we would’ve had before the pandemic hit. And that would’ve been around, I think it was a coverage ratio of maybe 1.5%, if I recall.
Damon DelMonte
Okay.
Mark Hardwick
So you’re modeling that without a mild recession, you get to a more normalized level [indiscernible].
Michele Kawiecki
And that may have been a little high, maybe 1.3% to 1.5% would’ve been about in a more normalized range.
Damon DelMonte
Okay, got it. And then obviously if you factor in a mild recession, you want to have a little bit more cushion for that?
Michele Kawiecki
Yes.
Mark Hardwick
Yes. And since we’ve adopted CECL, it’s been pretty turbulent.
Damon DelMonte
Yes, that’s an understatement over the last couple years, Mark. And then I guess my next question, just kind of from a modeling standpoint, how should we think about fair value accretion going forward Michele?
Michele Kawiecki
I think fair value accretion – looking at this quarter’s fair value accretion, which we do try to give you transparency to that. I think that’s probably a pretty good run rate.
Damon DelMonte
Okay. Great. And then just lastly, kind of bigger picture Mark. Now that you’ve digested Level One you kind of look at your competitive landscape across the upper Midwest there. How do you guys feel about M&A at this point? Do you feel like it’s something that you would look to engage in again? Or do you feel that the organic opportunities throughout your footprint are so strong that your content with just kind of focusing internally?
Mark Hardwick
Yes, we’re really excited about having a year where the focus is all internal. And there are – we will continue to call on the banks that we think might fit First Merchants well and enhance our growth rates in the future. But at least in 2023, it feels like, well, this team is really focused on just an internal year. I have some of our folks, they talk about, hey, is it – it’s hard to get bigger from an M&A perspective and better. And this is and we’d love to be able to do both all the time. But I think the reality is after absorbing a bank, the size of Level One, the focus needs to be on internal enhancements and getting better every day. So we’ve got a couple key initiatives. We’re working on including an upgrade in our online banking and mobile platform and a number of other things. I won’t get into them all, but we just think it makes the bank better and prepares us for the next acquisition.
Damon DelMonte
Great. Thanks for all the colors today, guys. That’s all that I had.
Michele Kawiecki
Thank you, Damon.
Mark Hardwick
Thanks, Damon.
Operator
Thank you. One moment while we prepare for our next question. Our next question will come from Brian Martin of Janney. Your line is open.
Mark Hardwick
Hey, Brian, you may be on mute, we can’t hear you.
Brian Martin
Yes, I’m sorry. Thanks, Mark. I apologize. Good morning, everyone. So just wanted to touch base on the funding side just is funding loan growth this year. Just wondering what your thought is there? It sounds like there’s still some utilization from the bond books and just kind of as it pertains to deposits in the loan-to-deposit ratio as you kind of go through the year?
Michele Kawiecki
Yes, I mean, but I think we’re going to see some deposit growth. As I said, we had revisited our deposit betas and we’ll get competitive, even more competitive to help fund that loan growth. And I think that coupled with the cash flow from our bond portfolio, I think that – those two funding sources we think will cover us.
Brian Martin
Okay. And as far as what you’re kind of targeting on the loan-to-deposit ratio, where do you kind of see that as you work through the year?
Mark Hardwick
I don’t recall where that budget number is. Yes, it’s moving up. We kind of have long-term targets. We’d like to see it around 93% or 94%. We don’t get there this year. I think it – I think maybe we were at 88%, if I recall.
Brian Martin
That’s fine. Just a general trend if I can always follow back up, but in generally, you expected to move up from where we are here, just through that combination?
Mark Hardwick
Yes.
Brian Martin
Yes. Okay. Perfect. And then just the other two for me was Michele, it sounds like the margin just from your commentary, probably peaks maybe second quarter and then given kind of what you’re talking about, maybe the margin maybe slips a little bit, there are certain third quarters that in general fair how to think about it?
Michele Kawiecki
I actually think we’ll peak in the first quarter, and then I do think that we could see some progression [ph] in the quarters thereafter.
Brian Martin
Got you. Okay. Just a debate is picking up. Okay.
Michele Kawiecki
Yes.
Brian Martin
That is helpful. And then just the run rate or just kind of the level of fee income today seems like pretty good level and it just builds off of this, is that, I know there’s ins and outs every quarter. But just in general, how are you feeling about where that’s at today or just how we should think about that?
Mark Hardwick
Yes, we have a couple of positive tailwinds in that space. Our private wealth business continues to grow around 10%, and that’s the target we have for the year. And then the mortgage business, we expect to originate over $1 billion in mortgages this year. And I think the numbers are, portfolio at about 85% of that in 2022. And we’d like to get back to our more traditional model which would be, call it, 60:40 or even 70:30. And that 60% and 70% we’re talking about is sold into the secondary market.
So I felt like in 2022, we took advantage of an opportunity to use our balance sheet. We had the liquidity to do it. The customers were kind of, I think, in shock by how high the 30-year rate went and it allowed us to use our balance sheet. But now that’s moderated from as high as 7% to slightly under 6%. And I think it gives us the ability to move back into a fee-for-service model. And that should give us a little positive push on our non-interest income.
Brian Martin
Got you. Okay. That’s helpful. Okay, perfect. Well, thank you for taking the questions and congrats on a nice quarter and a nice year.
Michele Kawiecki
Thank you, Brian.
Mark Hardwick
Thanks, Brian.
Operator
Thank you. That concludes the Q&A session for today. I would like to turn the call over to Mark Hardwick, CEO for closing remarks. Go ahead, please.
Mark Hardwick
Thank you, Lisa. Just wanted to say thanks to everyone for tuning into the call, our employees, customers, our shareholders, our analysts. And we appreciate your interest in your investment. And we will – I guess you can count on this team to continue to work hard to deliver results for all of those critical stakeholders. Thank you.
Operator
That concludes today’s conference call. Everyone may disconnect. You all have a great rest of your day.
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