Level One Bancorp, Inc. (FRME) Earnings Call Transcript & Summary

Good day, and welcome to the First Merchants Corporation Conference Call. [Operator Instructions] Please note that this event is being recorded. Before we begin, management would like me to remind you that today's call contains forward-looking statements with respect to the future performance and financial conditions of First Merchants Corporation that involves 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 conference over to Mark Hardwick, Chief Executive Officer. Please go ahead.

Thank you. Good morning, everyone. It's an exciting day here at First Merchants, and we're excited about today's call to announce our merger with Level One Bancorp. I'm joined here today with 3 of my colleagues, Mike Stewart, our President; John Martin, our Chief Credit Officer; Michele Kawiecki, our Chief Financial Officer, who will be assisting me at the end of our kind of structured remarks to help with any Q&A that you may have. We released our announcement this morning at 8:30 Eastern Standard Time, and that announcement includes both a press release and a PowerPoint slide presentation, and I'll be covering the slides in today's call. So I'll start on Page 3. We're enthusiastic about this announcement as it continues to position First Merchants as a leading Midwest community banking franchise with expanded Detroit, Michigan market coverage. On a pro forma basis as of 9/30, First Merchants will -- or totals -- $17.6 billion in total assets, $10.8 billion in total loans and $14.4 billion in total deposits. If you turn to Slide 4, we have this broken down in a few different sections. We think that this opportunity for us is strategically compelling. It further establishes First Merchants as a leading Midwest banking franchise. And the exciting part is that we're adding a proven growth-oriented bank in a substantial metro market. It enhances our scale in Michigan and creates the Southeast, Michigan's premier community bank. The data is interesting to me that on a pro forma basis, we have -- we will have the #1 deposit share among community banks with less than $50 billion in assets in the combined Detroit, Monroe and Ann Arbor regions with $3.4 billion of total deposits. This acquisition complements our existing Southeast Michigan footprint, primarily the Monroe acquisition that we did a couple of years ago and expands our presence into Detroit and the attractive Ann Arbor and Grand Rapids markets as well. Level's commercial -- Level Bank is commercially oriented and growing consumer mortgage platform with a low-cost deposit base and truly a compatible culture makes this acquisition, this partnership, the right 1 for First Merchants, and we're incredibly excited about it. We think it's financially attractive. It produces double-digit earnings accretion in the first full year of cost savings, which would be 2023. And we think the tangible book value dilution and the earnback are appealing as well with an earnback of 2.9 years. Regulatory capital remains above the well-capitalized thresholds. And we feel like this will really help us continue to produce an outstanding return on tangible common equity. And as you can imagine, we completed all the expected due diligence effort and really had both teams on the First Merchants side and the Level One Bank side working hard in the past 45 days or so to make this happen. If you turn to Page 5, we have the transaction -- and really -- well, I'll jump down to consideration. You can see the exchange ratio there at 0.7167 shares of First Merchants common stock and cash of $10.17 per share. And we were really focused on creating a transaction that had a 75% stock, 25% cash mix as a way to optimize our capital base. As of yesterday's closing price for First Merchants, the aggregate deal value is $323.5 million, and the pro forma value or the, I guess, the exchange value for Level One shareholders would be $41.35 per share. It's 188% of tangible book and 12x consensus earnings for 2022. And you can see it's just under 8x earnings if you include fully phase-in cost savings. As part of the signing of the definitive agreement, we committed to 1 existing Level One Board member that would join the First Merchants Corporation Board and just continue to help us have representation in all of our markets. Our Board structure, we love for our board. And actually, they have to live in our footprint. And as bigger market as this will be for First Merchants, it makes sense for us to have additional representation in the Detroit MSA. Approvals in closing, Level One shareholder approval will be needed and we have all the customary regulatory approvals between our state regulatory agencies, the FDIC and the Fed. We expect to close in the first half of 2022 when our system integration is scheduled for the third quarter of 2022. If you then turn to Page 6. Many of you -- many of you know Level One by reputation and are familiar with our growth since Pat Fehring founded the bank in 2007. They have a formidable team of seasoned bankers with regional bank experience. We're excited about this footprint. There are a number of items on this space that just show the reasons why, but Level One serves the Detroit MSA, especially when you think about combining it with our current market, our current franchise in that marketplace. We're excited about serving a population that's over 4.3 million, and we're excited about doing it with a bank that's been able to grow organically 12% since 2017. The team is very entrepreneurial. Then they have a culture that's just driven by their passion to make a difference for their customers, much like the First Merchants team. So if you look then on Page 7, we have some additional bullet points. The chart on the bottom left is really what helps us get excited about this opportunity. We'll be the ninth largest bank in the footprint, but we will be really the only community bank, an organization that's less than $50 billion in total assets, really can make a difference in the Detroit MSA and Southeast Michigan marketplace. And hopefully, you can hear my voice, my enthusiasm for it. There -- it's home to 28,000 small- to large-sized businesses, which is exactly where our focus is and Michigan ranks fourth for middle market companies owned by women and minorities, which is just outstanding when you think about our corporate social responsibility initiatives. The Detroit MSA has a population like I said, of over 4 million, of which 1.3 million live in Oakland County. And interestingly, Oakland County is the wealthiest county in the United States that isn't either on the East or West Coast. The Ann Arbor market and Grand Rapids market, we're excited about having presence in those markets and the ability to continue to grow. And especially in the Ann Arbor market where we already have 3 locations and $276 million of total deposits. If you then slide -- turn to Slide 8, you'll see the pro forma loans and deposits of this franchise. It's appealing. It's profitable. It's a solid foundation to grow upstream in Michigan, and it's really funded by a strong core deposit base. If you look at the -- this is kind of in the fine print, but I'm excited about the overall yield. Level One will improve the yield on our total loan portfolio from 4% to 4.1%, and the deposit base stays steady at 19 basis points. And so we're pleased by that as well. If you turn to Slide 9, you can see the financial impact and the key transaction assumptions that I'll cover a few of those in the EPS accretion of double digit in 2023. After the cost savings are fully phased in is something that we're really excited about and the 2.9-year earnback, as I mentioned previously, you can just see the specifics here as we think is a very reasonable pricing methodology that we've deployed in the past and has been successful for the growth of our tangible book value per share over time, and we wouldn't expect this to be any different. We'll have a TCE of 8.4 after the close and regulatory capital ratio of 13.4%. The cost savings, pretty modest cost savings. We have 30% built into this model. And part of that is we've had significantly higher cost savings in prior transactions. But this is a little bit of a different merger for us. Many of our mergers in the past have been more of a deposit play. And in this case, we're picking up a more seasoned competent and, I guess, experienced commercial team that we think can help enhance our growth prospects into the future. And so we made sure that the cost savings were a little bit more reasonable, so we can continue to invest in the marketplace. The loan mark, you can see those notes here, $6 million on a pretax basis. We have a fixed asset mark of $1.5 million in the deposit interest rate markup of just $300,000. A core deposit intangible of 7/10 of 1% and onetime pretax cost of $23.5 million. We didn't put in the model any revenue enhancements that's been our tradition. And yet, I feel like this acquisition probably has more revenue enhancement opportunities than any that we've done in the past both from just leveraging the commercial franchise and the fact we have a larger balance sheet to really leveraging even our private wealth business into the Level One customer base. And if you remember, when we purchased Monroe, they had a really strong private wealth business that added to the now $6 billion assets under advisement platform that we have at First Merchants and we're excited about being able to leverage that across the Monroe customer base, as I mentioned. If you turn to Slide 10, you'll see our acquisition history. And just part of this is just I think we are -- I think it's a core competency of First Merchants. We do a nice job of cultivating relationships, I think paying reasonable prices that we can produce value into the future. And I go all the way back to -- I was here at the beginning of this chart when we were $1 billion in assets. And we had a Board member at the time that asked all the time to scale truly exist in banking. And I can tell you, over the years, we've proven that scale doesn't exist in banking and it's part of what has made us a high-performing company. The other -- the secondary thing that has come with our acquisition history is improved demographics. As we have been able to grow the company through acquisition, we've improved the demographic profile of our franchise. And I think that's absolutely the case with this acquisition, our largest in the company's history with Level One. And the other thing, I guess, I should mention is just culturally, we -- I think we're batting 1,000 culturally. These acquisitions have been great for all stakeholders, and it's been fun to build these relationships and have so many fans in all of our -- in every market that we serve. If I go to the last page, 11, I'd love to provide a brief summary here. We love that our Southeast Michigan presence will be of a scale that attracts talent and positions us to win. We feel this transaction is compelling, both financially and strategically and more importantly, achievable. And we're enthusiastic about welcoming the Level One team into the First Merchants' high-performance family. So at that point -- at this point, I'm happy to take questions.

[Operator Instructions] Our first question will come from Scott Siefers with Piper Sandler.

Mark, just wanted to ask you, when you talk about investing in the market as it related to your discussion on the cost savings assumptions, what specifically was -- what's the thrust of that? Or what did you mean? Is that to do more hiring? Or is it to diversify the legacy Level One business to look more like yours? Just maybe a little color there would be great, please.

Yes. Really just talking to talent, and maybe Mike Stewart wants to jump in here, but we're excited about our ability to attract additional talent and continue to expand their current loan portfolio, really upmarket.

Yes. I'll hit on that a little bit more. With our existing Monroe franchise, we are looking into the Greater Detroit area for our growth. And -- we just recently put a new office on the north side of Detroit and Birmingham, where we were attracting really high-caliber bankers coming from the middle market area to help us round out our efforts to take advantage of the density, the density of the middle market companies there and to take advantage of our investment real estate capabilities. So we've got a team up there. And then when you think about their proven growth-oriented bank with our proven growth-oriented bank and then putting that -- those 2 organizations together around that whole Southeast area, the opportunities for us to allow them to continue the pace of play in which they've done with some enhanced capabilities, our asset-based lending capabilities, our investor real estate opportunities, our public finance approach. We have a debt capital market syndication capabilities. And that skilled and veteran team that they have underneath Greg Wernette in particular, has the caliber and capabilities to continue that pace of play, the growth. We offer the liquidity and the product to enhance that. And that similar culture, we've got to spend a lot of time there, and I think that -- that's going to be a really good synergy right out of the get-go. That's not even speaking about Ann Arbor and Grand Rapids, which to me, I get as excited about with the opportunities and the density in those markets as well.

Perfect. And then just maybe, Mark, I thought on what having Level One does to the balance sheet growth rate of the combined company? I mean you guys have always been a pretty solid organic grower. I think Level One has grown a little more rapidly. Would you anticipate maintaining that kind of level of growth for the legacy Level One business? Or does it normalize toward yours? And what would be the main factors in that thinking?

It was really one of the key factors that we spent a lot of time on prior to making really our final pricing decision. We are confident that our core bank is going to grow in the high to mid-single-digit range. And we're expecting next year that it's 8% or 9%. But I would say our confidence in the Southeast Michigan market is that we should be able to grow at 10%, 11% and 12% year-over-year. So we think it accelerates the overall growth aspect of First Merchants.

Our next question will come from Daniel Tamayo with Raymond James.

Maybe I could talk a little bit about the fee income side of the deal. First, you touched on it on the wealth management side, but -- maybe you could go into a little more detail on the opportunities you see to grow that business. I don't think we -- or Level One did any of that, especially given the affluency of the region there. And then just the second part being, what you're seeing in terms of opportunities in mortgage banking? And if there's going to be any overlap expected from their business relative to yours?

I can -- I'll start with the private wealth, which is a complete upside once we get fully integrated and bring our private wealth suite of products, investment management, private banking, retirement plan services, to name a few, into their marketplace, again, spending time with their management team and knowing where they were going next, that is an area that they had interest in, in building out their connectivity with their businesses and the affluency level there, I think, is a perfect overlay for us to expand quickly our team, our approach or add new team into that approach. And having a group of people already in Monroe with that capability, I think it becomes a quicker pace for us to penetrate that. And there is a complete receptivity on their team's ability to want to leverage that into their business. And then we can talk more about the mortgage business, but their mortgage business is equal inside our mortgage business. So both leaders we haven't talked much about, Tim Mackay, Greg Wernette or Eva Scurlock, but both the leaders that they have and we have in that mortgage basis going to play an integral role to build on the best practices, the best platform and the processes to really fully unlock the potential of what now will become a really important business unit for our collective organizations. And there's really not overlap. We might find some real benefits in some of their platforms, which we might enhance ours. We think that some of our connectivity into our consumer network might enhance some of their throughput. So I think there's real upside with both those teams working together.

Great. And then that really probably a question for Michele. But on the impact to the core margin, it sounds like loan yields and deposit rates are pretty similar. Are you going to be able to -- just how are you thinking about any kind of restructuring of the balance sheet with what you're bringing over from Level One? And what would be the impact on the core margin for First Merchants going forward?

I think the upside on the margin will come from the loan yield. As Mark pointed out, I think it's on Slide 8, you can see the combined yield. And so with our loan yields being at 4% and then the pro forma being 410, we do expect to pick up a few basis points of core margin.

Our next question will come from Damon DelMonte with KBW.

First question, just wondering, Mark, could you provide a little color on the background behind the merger? Was this like a negotiated transaction with Level One? Or is this a competitively bid process?

It was a competitively bid process, but I think it was a fairly limited audience or group that they went out to. So I would say it was a traditional kind of bid process with just maybe a smaller number of participants.

Okay. That's helpful. And then with respect to -- I think Mike Stewart made a passing comment about Grand Rapids and I know that Level One has a branch out there. Can you guys give a little insight into your thought process of what you guys could do in Grand Rapids? Is this an area that you think you'll try to physically increase your presence and have more of a footprint there? Or do you feel that the resources there today are enough? Or do you feel like you don't even need to be in there. You can just kind of from where you're currently located, get some access to that market?

I think that we're going to absolutely want to support what they've already begun to do in Grand Rapids. It is a singular full-service banking, but it has several commercial bankers that have joined their team with a nice background that are starting to really make an impact. And they have plans, and I would want to continue those plans to grow that marketplace. And again, if you think about the competitive landscape there, which is very competitive. But again, the density and the businesses and the density of the consumer network would prove really valuable. So I think we'll be supporting their efforts to lead with the commercial efforts and watch the results there and compete against the, I think, some of the market disruption that's been happening globally in the Greater Michigan marketplace. So I think we let them continue to work their growth metrics and support it and maybe even a more fast-paced approach.

Okay. That's helpful. And then just lastly, Michele, do you happen to have the total goodwill amount that you expect to combine on the balance sheet?

Yes, it's $137 million.

This concludes our question-and-answer session. I would like to turn the conference back over to Mark Hardwick for any closing remarks.

Yes. Thank you, everyone, for your time. We appreciate the questions. And like I said, we're -- it's an exciting time at First Merchants. We are -- our entire team is our way to Michigan now to meet our new partners and to welcome them into the family. And I know they're excited and receptive. So thank you for the time and energy, and we're going to make this happen for all of our stakeholders. Have a good day.

The conference has now concluded. Thank you for attending today's presentation.