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First Merchants Corp (NASDAQ:FRME)
Q3 2020 Earnings Call
Oct 28, 2020, 2:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, and welcome to the First Merchants' Third Quarter 2020 Earnings Conference Call. [Operator Instructions] This presentation contains forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act. Such forward-looking statements can be identified by the use of the words like believe, expect or may, and include statements relating to First Merchants' business plan, growth strategies, loan and investment portfolio, asset quality, risks and future costs.

These statements are subject to significant uncertainties that may cause results to differ materially from those set forth in such statements, including changes in economic conditions; the ability of First Merchants to integrate recent acquisitions, changes in regulations and requirements of the company's regulators' legislation changes in the creditworthiness of customers, fluctuations in market rates of interest and other risks and factors identified in First Merchants' filings with the Securities and Exchange Commission. First Merchants undertakes no obligation to update any forward-looking statements, whether written or oral, related to the matters discussed in this presentation or press release. In addition, the company's past results of operation do not necessarily indicate its anticipated future results. [Operator Instructions]

I would now like to turn the conference over to Mike Rechin, President and CEO. Please go ahead.

Michael C. Rechin -- President and Chief Executive Officer

Thank you, Emily. And welcome, everyone, to our Earnings Conference Call and Webcast for the Third Quarter ending September 30, 2020. I'm joined this afternoon by several of our executives, specifically Mark Hardwick, our Chief Financial Officer, Chief Operating Officer and soon to be Chief Executive Officer; as well as John Martin, our Chief Credit Officer. Also joining us today is Michele Kawiecki, our Director of Finance and soon to be Chief Financial Officer, effective January 1; Mike Stewart, our Chief Banking Officer and soon to be President of this company, also with us in the event that he can add thoughts or that may come out through questions later in the presentation.

Given the unusual year and rapidly changing environment, our goal is to provide a thorough review of our third quarter's results, coupled with an eye toward 2021 as our planning matures, looking for our opportunity next year. We released our earnings in a press release this morning at approximately 8:00 a.m. Eastern Time, and our presentation speaks to material from that release. The directions that point to the webcast were also contained at the back end of the release, and my next thoughts will start from Page four, a slide titled third quarter 2020 highlights. First Merchants has reported third quarter 2020 net income of $36.2 million compared to the $36.8 million during the same period in 2019.

Earnings per share for the period totaled $0.67 per share compared to the third quarter of 2019 result of $0.71 per share. Also at the top of Slide four is reference to our pre-tax pre-provision income of $54.4 million and a resultant 1.59% return on assets. The quarter featured a stabilization of our core net interest margin that Mark will speak to here shortly as well as strength in our fee categories, specifically those client-related fee categories that reflect increased activity. Mark will be speaking to all the components of our noninterest income, including our first incurrence of Durbin Amendment limitation. Middle of the page, asset and deposit comparatives, primarily with last year's third quarter, and the growth in each, primarily reflected due to the PPP program earlier in 2020.

The quarter had a low level and absence of organic growth in loan generation despite active origination levels that I know are part of John Martin's comments, and I'm happy to speak to our pipeline as we look forward, maybe at the back end of the conversation. Bottom of Page four, a couple of metrics around the growth and high level of our capital levels, including tangible book value per share growth in this middle bullet point, 10.4% over the third quarter of 2019 and added at the bottom of the capital section, a comment that would complement some of the material that John will detail later, and that is Moody's providing a bank stand-alone assessment of our credit at A3 baseline.

I'm going to move to Page five. Some additional asset quality comments, including our measure of allowance and fair value marks at 1.65% of loans, reserve build throughout the period in anticipation of additional recessionary environment moving into next year. A $12.5 million provision in the quarter, mildly down and yet several million dollars, $6 million above our net charge-offs responsible for the reserve build. Liquidity, even more evidence of a healthy balance sheet and alluding to the $3.4 billion investment portfolio that continues to have top quartile industry performance. John is going to speak in his material about the state of our CARES Act reaction to the marketplace and our clients' needs and the materially low level of remaining portfolio in deferral, including he'll get into the concentrations within those deferrals and speak to really the only meaningful concentration at all in the hospitality business.

The metrics around the CARES Act behavior at the bottom of Page five, specifically, the reference to $900 million in funded originations in the PPP program and the applications effectively match what we would have discussed at the June 30 call. Although at this point, and John may cover it, we're well into the filing of applications for forgiveness and look forward for that to accelerate through the balance of this year and certainly through the first part of 2021. We move to Page six and reference a franchise map that we used in our last call, and we're seeing progress and recovery throughout the markets we're in.

You can see some of the comparative levels of unemployment around the states that we do business in. Consistent with the national numbers, the COVID cases rising, and yet our markets remain predominantly open. It's allowed our bankers to be when consistent with customer preference on the Street, seeing our clients or through whatever communication medium is called for. But the activity, based on the relative geographic openness of our economies, have been terrific for us to resuscitate the economies. At this point, even with the rising cases, we've had very limited government-mandated retrenchment on any of the openness stages that our primary markets have had, specifically Ohio and Indiana that house 85% roughly of our loans and greater than 80% of our deposits.

So at this point, I'm going to let Mark and John and Michele speak a little bit deeper into the results for the quarter.

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Thanks, Mike. My comments will begin on Slide eight, where total assets on line seven increased by $1.3 billion or 13.7% annualized since year-end 2019. Investments on line one increased by $337 million or an annualized 17.3%, following a strong 2019 where investments increased by 59% over 2018. Loans on line two have increased $779 million since year-end of the increased PPP loans. Net of deferred loan fees and costs accounted for $901 million of the growth. And you can see that number highlighted in footnote one. Additionally, on line three, the allowance for loan losses increased by $47 million or 59% year-to-date, primarily due to COVID-19-related economic challenges.

The composition of our $9.3 billion loan portfolio, shown on the upper right-hand side of Slide nine, produced a third quarter 2020 yield of 3.93%, down from the second quarter of 2020 yield of 4.10%. Despite the linked quarterly decline in overall loan yields of 17 basis points, our net interest margin, which I'll speak to in a moment, stabilized materially this quarter. Also of note, PPP loans negatively impacted loan yields by 12 basis points this quarter and nine basis points in the second quarter of 2020. So our normalized loan yield for the quarter was 4.05% versus the 3.93%.

On Slide 10. As of September 30, 2020, our $2.9 billion investment portfolio produced a 2.94% yield with an unrealized gain of $141.5 million. We anticipate expanding our commitment to the tax-exempt municipal sector, which currently stands at 56% of the portfolio. Our quarterly gains, highlighted on the right side of the page, are a result of opportunistic sector migration and duration management. This active management, along with the sector allocation decisions are the reason that our yields are about 70 basis points better than our peer group, and our unrealized gain is nearly double the peer group.

On Slide 11, total deposits increased by $1.1 billion or 14.4% annualized over year-end 2019, following 2019 growth of $2.1 billion or nearly 27%. Some portion of the increase is due to PPP loans and the related deposit balances. We believe that our loan-to-deposit ratio of 85% and our loan-to-asset ratio of 67% provides the bank with strong liquidity levels. The mix of our deposits on Slide 12 are the key to both liquidity strength and low-cost funding. Third quarter interest expense on deposits totaled 36 basis points, down from the second quarter of 2020 total of 47 basis points. The reduction of 11 basis points helped to offset the loan yield compression that I mentioned on Slide nine.

As we move through the remainder of 2020 and end of 2021, we have deposits repricing that should bring down our interest expense even further. In the remainder of just 2020, we have another $348 million of CDs that mature with an average rate of 1.67%. Given the new rate of approximately 30 basis points or less, our savings should be approximately $1.2 million per quarter. All regulatory capital ratios on Slide 13 are above the regulatory definition of well-capitalized and our internal targets, which ensures the bank maintains strong capital for events such as the current cycle we're in. When adjusted for PPP loans, which are 100% government guaranteed, our tangible common equity ratio increased during the quarter to 10.19%. Now let's turn to Slide 14. The corporation's net interest margin decreased four basis points and just two basis points net of fair value accretion from the second quarter of 2020 to the third quarter of 2020.

Of the decline, PPP loans accounted for one basis point because PPP loans caused margin to decline by seven basis points this quarter compared to six basis points last quarter. So just stated differently, we're down four basis points, two basis points of the decline are related to fair value accretion decreases and another basis point is related to all the PPP loans that we have on the books at the end of the quarter. We believe net interest margin has reached a predictable level for the near future and should carry us into 2021. Line one of this Slide is also urging as net interest income, on a fully taxable equivalent basis, increased by $2 million dollars over the second quarter of 2020, now totaling $97.3 million. Noninterest income, on Slide 15, totaled $26.1 million for the third quarter of 2020.

Customer-related fees increased to $23 million, up from just $21.1 million in the second quarter of 2020, despite a $2 million decline in card payment fees on line three as the Durbin impact was fully realized in the quarter. The gradual return of service charges on deposits, on line one, improved. Wealth management fees, on line two, and the gains on sale of mortgage loans drove the improvement from $23 million to $21 million, net of the Durbin impact. Service charges, on line one include return check and OD fees, which declined in the second quarter of 2020 from the first quarter of 2020 by $1.7 million. In Q3, we recovered approximately $700,000 of our normal run rate. As the economy continues to improve, we anticipate regaining the remaining $1 million.

As expected, noninterest expense, on Slide 16, totaled $64.7 million in Q3 of 2020. As a reminder, in Q2, we deferred $2.3 million in salary expense related to PPP loans. We had a $1.1 million reduction in our bonus accruals in Q2, and we had a $1.6 million decrease in debit card payment processing expense due to the termination of our rewards program. All these items lowered noninterest expense in the second quarter from normalized levels. We anticipate noninterest expense in the fourth quarter of 2020 to be in a very similar range as our third quarter 2020 results. Now on Slide 17. We are pleased that our bottom line totaled $36.2 million and net income and earnings per share reached $0.67 per share.

On Slide 18, you can see trends in earnings per share, dividends and tangible book value per share, and we believe that our dividend, which is still less than -- less than the 50% payout ratio, is reasonable in this environment. On Slide 19, you will notice our total compound annual growth rate of tangible common equity is still over 10%, and our dividend yield is nearly 4.5%.

Now Michele Kawiecki, Senior Vice President of Finance, will cover a couple of key items related to loan loss coverage and capital strength.

Michele M. Kawiecki -- Senior Vice President And Director Of Finance

Thanks, Mark. My comments will begin on Slide 21. Looking at the top right of the slide, you'll see that we continue to build our reserves, although more modestly than we did last quarter. We had the beginning allowance balance at the end of Q2 of $121.1 million less net charge-offs of $6.9 million, which John Martin will talk a little bit more about plus, the Q3 provision expense of $12.5 million, which brings us to the September 30 allowance for loan loss balance of $126.7 million. I would remind you that we elected to defer the adoption of CECL. So we calculated the provision using the incurred-loss method, but continue to run our CECL models parallel, and we'll be implementing the CECL methodology next quarter.

Moving down to line nine. The remaining fair value marks on purchased loans totaled $26 million. Adding those marks to the allowance balance totals $152.7 million, which is 1.65% of total loans, which Mike mentioned earlier in his remarks. On Slide 22, this is a slide that we added last quarter, which is intended to show you that when considering our robust capital and allowance for loan loss levels, that we have more than $500 million in reserves to cushion us through the economic downturn. The table at the top shows a roll forward of the allowance for loan loss since last quarter. The first highlighted line shows our current allowance balance of $126.7 million with an allowance-to-loans ratio of 1.37%. When excluding the PPP loans from total loans, the allowance to loans is 1.52%.

And as I said earlier, we did not adopt CECL, but in our 12/31/19 Form 10-K, we disclosed that the estimated CECL day one adoption, if we had adopted on January 1, was estimated to increase the allowance by 55% to 65%. So applying 65% to the December 31, '19, allowance for loan loss balance of $80.3 million creates a CECL day one adoption increase of $52.2 million. So a pro forma of our allowance with CECL adoption at September 30, using these assumptions would have yielded a total allowance of $178.9 million, which is a robust coverage ratio of 1.93% and 2.14% without PPP loans. The increase in the allowance for CECL adoption would lower capital on an after-tax basis. So in the bottom left corner, I have provided a pro forma of our total risk-based capital ratio.

Our current total risk-based capital ratio is 14.38%. When reduced for the impact of CECL, the ratio would be reduced to 13.89%. That still leaves $338 million of excess capital above the well-capitalized level. This excess capital added to $179 million of allowance, both shown post-CECL, gives you more than $500 million in reserves. Now that's enough to cover a 6% to 7% non-PPP loan charge-off ratio. It's important to keep in mind that this is before considering our strong pre-tax pre-provision earnings levels that will continue to generate additional capital as well as the $26 million in remaining fair value marks. Therefore, we feel confident in our balance sheet strength as we continue working through this economic downturn and especially in consideration of the credit performance, john Martin, our Chief Credit Officer, has to talk about today.

So with that, I will turn it over to you, John.

John J. Martin -- Executive Vice President and Chief Credit Officer

All right. Thanks, Michele, and good afternoon. I'll begin my comments on Slide 24 by reviewing the loan portfolio, provide an update on modifications, discuss the COVID-sensitive portfolios, review third quarter asset quality, then then touch on the PPP loan program before providing some closing remarks. So turning to Slide 24. The portfolio was mostly unchanged with reductions in C&I and construction lending on lines one and four, offset somewhat with increases in sponsor finance and owner-occupied C&I-related commercial real estate, with an overall net decrease, on line 14, of $52 million. Then turning to Slide 25. And contributing to a portion of the decrease in C&I commercial loan balances was the lower line utilization, which attributed to $46 million and decreased commercial line of credit outstandings.

Despite the lower outstandings, we continue to book new commitments, as shown by the blue bars in the same graph with commitments increasing $60 million as well as an overall growth and pipeline activity that Mike Rechin will discuss in his remarks. Moving to the right portion of the slide. COVID modification still in deferral, have fallen to $176 million or roughly 2% of loans, down from a high of $1.1 billion of first modifications last quarter or roughly 12% of loans. We continue to work with affected borrowers through the latitude granted in the CARES Act, and I'll talk more about some of those efforts as I discuss the slides related to COVID-sensitive industries.

Turning to Slide 26 where we break out the industries most impacted by the pandemic, hotels and hospitalities have and continue to be the sector where the most significant amount and number of modifications were granted with some lesser amount in manufacturing and wholesale trade. Please turn to Slide 27 where our focus for a moment on the residential mortgage and consumer portfolios. Residential mortgage lending has been strong across the industry, and we have benefited from the robust refinance market as well. Our gain on sale is up 56 -- 57% over Q2 to $5.8 million despite intentionally taking over $30 million into the portfolio of 15-year mortgages in the quarter or $115 million year-to-date, where yields were favorable as comparable to mortgage-backed securities from an investment perspective.

As far as the consumer mortgage portfolio modifications are concerned, there remain only $8 million of loans in deferrals at the end of the quarter or less than roughly 1/2 of total mortgage and consumer loans, which I'm really pleased with. Moving to Slide 28. This slide has been reworked to help clarify how we think about and have aligned the sponsor finance business, how it is separate and distinct from our traditional regional C&I exposure as well as our shared national credit exposure. The sponsor business is primarily focused on providing corporate acquisition financing, where a private equity firm is acquiring a portfolio company. It is not dissimilar to typical acquisition financing that we provide with the exception of private equity investment.

The business sources opportunities from private equity firms in the Midwest and Southeast, and at the end of the third quarter consisted of 44 borrowers, totaling roughly $340 million in outstanding balances. With the general definition of a leveraged loan in the upper right-hand portion of Slide 28, the table, related table, at the bottom of Slide 28 shows $485 million of leveraged balances for not only the sponsor finance line of business I've just mentioned, but also for traditional regional C&I, and our shared national credit portfolio.

I would highlight that not all of the sponsor portfolio meets our definition of a leveraged loan and that there are two leverage relationships that remain in deferral at the end of the quarter, only one of which is in the sponsor finance group. This relationship is expected to come out in November without issue. Moving to Slide 29 and the investment real estate portfolio. Of the $2.1 billion of investment real estate, there is $115 million or 5.5% in deferrals at the end of the quarter. Loans are concentrated in Indiana, Ohio, Illinois and Michigan, with roughly 30% concentrated in multifamily housing.

Then on Slide 30, I've drilled in further on the hospitality portfolio. Our deferral strategy for hotel borrowers has been to grant a first deferral of either a 90 day, which was more typical, or 180 days depending on the situation. At this point, if the borrowers request an extension into next year, we are beginning to require current appraisals prior to deferral to determine accrual status even as we take advantage of the flexibility provided under the CARES Act. We continue to review this portfolio quarterly and expect that the portfolio will be somewhat slower to recover. I think of it this way.

Deferrals represent 92% or 1% of total loans in the hospitality portfolio and are secured by the underlying real estate, which gives me confidence that by working with the borrowers and by using the flexibility provided by the CARES Act, the amount and number of potential and nonperforming assets will be muted, barring a severely material negative change in the environment. Then turning to Slide 31. I've drilled down into the retail trade from the last quarter to provide additional detail. This category consists of a diverse set of industries, similar to those found in our geographies. Of the total $246 million or 2.6% of total loans are secured by investment retail real estate.

Turning to Slide 32. We've broken out restaurants and food service as well as senior living. While restaurants and food service have deferrals, in line with the rest of the portfolio, senior living, despite its lack of deferrals has experienced a somewhat more -- has experienced somewhat more stress, as I will discuss, as we turn to Slide 33, and I talk about asset quality. On line five of Slide 33. Total NPAs plus 90 days delinquent increased by $4.1 million as a result of $6.6 million of a net increase in nonaccrual loans, $1.6 million of renegotiated loans and a reduction of $3.7 million moving from 90 days past due. Classified loans increased 5.5% as we continue to receive financial information from early in the year and move regulatory grades as appropriate.

Now turn to Slide 34, and let me discuss some of the more meaningful events as they relate to the previous slide. Last quarter, I discussed a $14.4 million sponsor relationship that migrated to nonaccrual. In the quarter, we substantially resolved the name by receiving roughly $5 million in proceeds, which is included on line three, charging off $6.7 million, which is included on line five, while carrying $2.8 million into the fourth quarter that has since been collected. Backing up to line two, and connecting it to my earlier comments about senior living facilities, the $20 million increase in new nonaccruals came largely from a $14.1 million loan for a newly constructed skilled nursing facility.

The nursing facility had been slow to achieve its projected occupancy, which when the pandemic hit experienced issues and was subsequently unable to perform. Given the circumstances, the facility was not a candidate for payment deferral under the CARES Act and was moved to nonaccrual. Other than the nursing facility, there is a $3.9 million borrower that had become severely past due in the quarter, which was moved to nonaccrual, that loan has subsequently been paid in full. Then turning to Slide 35.

A quick PPP update before I wrap up. We started the process of PPP forgiveness with roughly $923 million of exposure, and more importantly, with 5,241 loans. We have created an internal forgiveness team, spun up software and have begun processing requests and have made adjustments for the recently released guidance for borrowers who has requested less than $50,000. As of October 26, we have submitted $94 million for forgiveness for 154 applicants.

Then turning to Slide 36 to wrap up the credit discussion. Ending the third quarter, we've seen some stress in the senior living portfolio, but it's manageable. Our largest deferral category is concentrated in hotels and hospitality, which has $92 million in deferrals and continues to recover. This is 1% of loans and is secured by real estate, with the rhythm established for the review of both portfolios, and we continue to compile results and develop strategies with the borrowers. We had charge-offs of $7.4 million in the quarter with $6.7 million isolated to an individual borrower. This still leaves us with only 30 basis points of loss. With an experienced manager and team of -- in our special assets area and a team of workout specialists from the last recession and based on what we know and under current conditions, I continue to be cautiously optimistic as we head into the fourth quarter and beyond.

All right. Mike, I'll turn the call back over to you.

Michael C. Rechin -- President and Chief Executive Officer

Thanks, John. I had a little bit more material to cover. Before I do that, I wanted to add a couple of different perspectives to some of the perspective that Mark might have shared earlier or John, Mark, in particular, in highlighting some of the noninterest income categories, spoke to dollars right out of the financial statement that's the intent. But behind that is an increasing activity or an increasing engagement of our customers in the economy. I feel like there's an advantage that accrues to our company by being in the state where the economy is getting into legs more quickly than other parts of the country.

And so for instance, debit card activity, which reached its floor in the March-April time period at about just over 16 transactions per card, rallies to a September, early October level of 21 transactions per card, 26% or 27% up included in kind of the dollar synopsis that Mark provided. Commercial transactions for a commercial bank show similar levels of recovering engagement, remote deposit volume up 6% in that same March to September time period I used a moment ago. Wire activity up 22%, ACH volume up 6% in units, 17% in dollars. Reasons to look forward and follow Mark's commentary about the service charge line item likely to reach its prior levels. John referenced the pipeline and pretty unusual for our company to have a quarter with absent organic growth, typically about 1% to 2% per quarter, 8-ish percent on an annualized basis, oftentimes higher. So that's unusual.

And yet we follow the lead of our clients. It's also unusual to book $900 million of loans in a 45-day period on a base of $9 billion in the time period immediately prior to that. So we're learning as we go. And I wanted to thank John for his intentional depth on a dominant area of interest. A couple of the themes I heard were extensive portfolio care and in conjunction with our line of business bankers, extensive client care, continued reserve build ahead of, as Michele pointed out, our end-of-year CECL adjustment and the themes in combination speak to a bank, addressing a recessionary strategy of capital preservation, while we figure out where this COVID thing's going.

And the day-to-day reality is we're working awful hard with our clients. I wanted to speak to Page 38, the last page here before we take questions. It's titled, well positioned for the future. So we're at this point, as you can imagine, actively working with our 2021 plan and our multiyear plan as elements of a survive and advance, not knowing exact if COVID chooses to end. And so if that impact were to extend itself, we've got tactics and strategies for that, our plan, though, is really matched with the persistence toward our historical strategic direction. First Merchants is a leading organically growing acquisitive regional banking company with commercial banking excellence at its core.

From business banking and the consumer bank, to private banking and our wealth management business and all of our commercial segments, it drives our service level, market advantage, and it drives our whole bank approach. A little bit on the content, maybe at the bottom of Page 38. The initiatives. They're within our plans. It's to be a more deliberate in driving our community's future, leading from the front for the broadest economic health we can achieve. Also, like other banking companies, we're going to drive channel change, while we affirm our go-to-market protocol. More digital investment, coupled with more infrastructure and banking center optimization, all of whom are going to be in our plan, like where it's going.

Our historical efficiency remains an imperative, while we're clearly listening to the voice of the customer. Middle of the page comments on performance and our capital strength. You've heard them from a couple of my colleagues. They are our business case for the compelling value proposition in quotes at the bottom of the page. The performance and capital strength bullet points were also the criteria for the current recognitions on the right side of Page 38, including the current month's Newsweek honor as Indiana's Best Big bank. Lastly and most important is the strength of our executive team. A month ago, our Board announced the transitions in the top of Page 38 bullet point. Our succession work, reviewed annually, will provide continuity, growth, fresh ideas, most importantly, shareholder reward.

Mark Hardwick is our CEO. Mark's been here over 22 years. This is a seasoned individual who is well-known to the listeners on this call, and I would tell you a significant hand in the formation of our company's culture. Mike Stewart become President First of the year, greater than 12 years at this company, and I've worked with him throughout my career for more than 25 years. There's no one as sharp as what's on our customers' mind and how you solve for it than Mike Stewart, as he shares it with our team on the Street. Michele Kawiecki will be taken over as our Chief Financial Officer. She joined us for the last couple of calls, been with the company more than five years, came with a larger competitor of ours, and I really look forward to the impact she's going to make.

And then John Martin, who's really not in the bullet point because there isn't a titular change, continues with his longer than 12-year career at First Merchants as our Chief Credit Officer. And for any of those of you on the call that watch him execute our strategy through the last perception, he's doing the same darn thing with a broader team. So these folks are supported by teams of First Merchants professionals committed to be pushing forward, getting better, makes me excited and optimistic. I appreciate having the chance to say so.

So at this point, Emily, we are ready to go back for questions.

Questions and Answers:

Operator

[Operator Instructions] The first question comes from Scott Siefers at Piper Sandler. Please go ahead.

Scott Siefers -- Piper Sandler -- Analyst

Good afternoon, guys.

Michael C. Rechin -- President and Chief Executive Officer

Hey, Scott.

Scott Siefers -- Piper Sandler -- Analyst

Hey. Congratulations to everybody. Lots of change going on there. I think first question, Mike, you sort of alluded to in your closing comments, the pace of loan growth sort of a little unusual for you guys. From the outside, it can be a little tough to tell what's going on even industrywide. The bigger banks are seeing loan contraction, some of the smaller banks still kind of holding their own, and you guys are sort of in a little bit of a middle ground. So maybe just some color on exactly how your customers are thinking about things? What loan demand looks like and where you might see it going over the coming couple of quarters?

Michael C. Rechin -- President and Chief Executive Officer

Oh, I'm glad you came back to that because I had my pipeline statistics right in front of me. And while I got hung up on some of the fee-driven pipelines and levels, I skipped that one. So I appreciate you bringing it up back to me. Well, let's break it up into parts. Let's talk attitudinally. So Mike Stewart, sure, you might have an add, but our customers are wary, they're looking at the same set of uncertainty as we are, and yet they're opportunistic. And so in John Martin's statistics, he talked to you about a pretty healthy level of originations.

And so our last quarter originations are great, our utilization way down, about 10% over the last two quarters. I think it's 42%-ish, down from 52%-ish over the last couple of quarters, Scott. Let me talk on my comment -- I'm going to come back to the C&I part and the real estate part in a second. But relative to mortgage, it's just really, really strong like most mortgage participating banks are. And yet ours might be even a tad stronger than that. I was looking at. There's obviously a seasonal dip typically, right, when you get to the holidays at the latest part of the calendar year. But going into the fourth quarter, our pipeline was even higher than it was in the third quarter. So it's a rate-driven business.

That's good, and our execution has been great. So mortgage is going to continue strong. And strategically, maybe some more of that will wind up in our balance sheet versus the originate-and-sell model, which has dominated our mortgage business for years. On kind of the more rubber meets the road business to include our specialty businesses is municipal and sponsor, they're regaining steam. They're not as -- they're not where they were four quarters ago. And yet I'm looking right here. I'll just quantify it for you. Commercially, we're up to $600 million from $440 million going into the last quarter.

So I would just caution the idea that, that number, which we've historically shared, would incorporate all of our construction commitments. And so draws against those are uneven, and it obviously can't speak to what our existing clients do with utilization going forward. But in terms of origination pipeline commercially, it's up 100 -- a little bit more than $150 million from where we started the last quarter. We view that positively. Did that help with what you're looking for?

Scott Siefers -- Piper Sandler -- Analyst

It does. It does, Mike. So thank you, thank you very much.

Michael C. Rechin -- President and Chief Executive Officer

You're welcome.

Scott Siefers -- Piper Sandler -- Analyst

And then maybe next question is for you. So the $52.2 million seasonal impact, I understand that sort of at this point illustrative, based on the range you had given previously. But with that occurring in the fourth quarter, will the adjustment to the reserve run through the income statement? Or will that run through below the line the way that it did for the other institutions that had adopted earlier this year?

Michele M. Kawiecki -- Senior Vice President And Director Of Finance

Well, the $52.2 million will go through equity, but then any catch-up that we have which we really don't -- I mean, I think we're -- in our fourth quarter, we'll be looking at our provision using the CECL model, and that provision, whatever adjustment we have in the fourth quarter will come through the income statement.

Scott Siefers -- Piper Sandler -- Analyst

Okay. Okay. So the $52.2 million would go through equity, but then any additional sort of, I guess, COVID catch-up would go through the provision. Is that a fair characterization?

Michele M. Kawiecki -- Senior Vice President And Director Of Finance

It is. I think the way that we have viewed our provision. We -- as you know, I mean, we build fairly aggressively through the last three quarters and have been running our models parallel. And so I think in Q4 -- right now I would expect we would have some reserve build. How much? I'm not sure. We'll have to look at our forecast, look at our loan growth, credit quality, etc. But I don't expect it to be as aggressive as it was in the first two quarters.

Scott Siefers -- Piper Sandler -- Analyst

Okay. Perfect. And so that actually went to the heart of my sort of final provision-related question. I mean you guys, as I recall the commentary in the last couple of quarters, even though you've been incurred loss methodology, you've been sort of providing at a level that would have equated to what you would have done in a CECL world, right? So there shouldn't really be that much of a real catch-up, right?

Michele M. Kawiecki -- Senior Vice President And Director Of Finance

That's correct.

Scott Siefers -- Piper Sandler -- Analyst

Okay. All right. Perfect. All right. Thank you guys very much.

Michael C. Rechin -- President and Chief Executive Officer

Thanks, Scott.

Operator

Our next question comes from Terry McEvoy from Stephens. Please go ahead.

Terry McEvoy -- Stephens -- Analyst

Hi. Thanks. Good afternoon. Maybe just more of a bigger picture question to start. How are you thinking about the branch footprint today? Quite a few peer banks have talked about some branch consolidation and a benefit to the expense line. And so I guess as you look out into next year, what are your thoughts on that topic?

Michael C. Rechin -- President and Chief Executive Officer

Terry, it's Mike. I'll start with that, and then Mark might have a comment, but it's every year part of our planning process. And when you look historically at us, we've been optimizing our storefront census for years. We're probably down 40 stores in the last five or six years. We're looking at it again, obviously. We did a great job of helping our clients use our digital technology. And clearly, the lobbies were closed for some period of time. And so that's going to have an impact on our costs. I know you're trying to get to a more specific answer. We're going to have banking center closures in our 2021 plan. We're trying to size that right now, both in number of locations and the expense component as we also assess the investment we're going to be making in our digital technologies.

Terry McEvoy -- Stephens -- Analyst

Thanks. And then as a follow-up question, maybe it was a little too aggressive on the Durbin impact and the card payment fees. Can you maybe talk about the fourth quarter? Mike, I know you talked about growth rates in some of the businesses that drive the revenue there. But could you maybe help us out in terms of the fourth quarter, what type of pickup those growth rates could be off the new kind of base of $4 million per quarter?

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Are you speaking directly to -- I got you, the card payment fees and Durbin.

Terry McEvoy -- Stephens -- Analyst

Yeah.

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Yes, I do think the $4 million kind of establishes a new baseline or lower bound. We do see some pickups in card payment fees, as Mike mentioned, and we should see kind of a mid-single-digit growth rate going forward. But yes, the third quarter, I think the key to that is we recognized all of the Durbin impact in this quarter. And there won't be kind of a second or an additional decrease from here. So it's all just about card payment activities and the growth in that line of business.

Terry McEvoy -- Stephens -- Analyst

Great. Thanks everyone. And John, thanks for all the additional data and your slides. Much appreciated. Thank you.

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

You're welcome. Thanks, Terry.

Michael C. Rechin -- President and Chief Executive Officer

Thanks.

Operator

Our next question comes from Daniel Tamayo, and he comes from Raymond James.

Daniel Tamayo -- Raymond James -- Analyst

Hi. Good afternoon, everyone. And I'll echo congratulations on all the promotions and Mike, on your retirement.

Michael C. Rechin -- President and Chief Executive Officer

Thanks, Daniel.

Daniel Tamayo -- Raymond James -- Analyst

Starting on the margin. Sure. I just wanted to make sure that I'm reading your comments correctly here. When you say you think the NIM should be at -- the core NIM should be at a predictable level going forward carrying into 2021. You're essentially saying stability is what you're looking for there? Is that correct?

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

It is. Yes, we're still working the cost side aggressively, we're still working the kind of renewal and new origination side aggressively on the lending side, on the asset side. Looking closely at the bond portfolio with the objective of maintaining or increasing the margin from here. And there's pressure given the yield curve, but that's our focus.

Daniel Tamayo -- Raymond James -- Analyst

And does that assume any -- does that assume like when you get into 2021, like an 8% organic loan growth that Mike was talking about? Or something shorter than that?

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Yes, our -- traditionally, we talk about growing at mid- to high single-digit growth rates, maintaining a 50% -- approximately a 50% efficiency ratio, which we believe allows us to trade at a high-performance level, which then kind of opens the door for M&A opportunities. And so I still think we'll be at the mid- to -high single-digit growth rate next year despite what -- this year, 2020, has been more challenging than normal.

Michael C. Rechin -- President and Chief Executive Officer

This is Mike again. If you extrapolate a continued growth of commitments, that obviously speaks well for our balance sheet going forward. At some point, that utilization, and I applaud our clients for being smart about turning receivables into cash and paying down their lines, in the near term, it hurts our net interest income. In the next term, short term, perhaps, certainly, intermediate term, their historical usages ought to bear out. And when you couple that with our market coverage, yes, I think getting back to a post-COVID, 8% annualized is absolutely the plan.

Daniel Tamayo -- Raymond James -- Analyst

Terrific. And then on the deposit side, how do you feel about the -- kind of the increase in deposits you've seen? Do you think some of that will run off with the PPP funds? Or do you think they're going to be stickier than maybe you were thinking previously?

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Yes. If you look at last year's growth rate of $2.1 billion, I mean a little over, what, $1.1 billion related to acquisitions, it was still a really strong organic year. This year, at $1.1 billion with $900 million of PPP loans, it's a strong organic year plus PPP. And the real question will just be as these PPP loans are forgiven, how much of those deposits stick. Today, we feel like it's a large percentage. I would have -- I think last quarter, I mentioned we thought it was about half. Our confidence level in that is increasing as we move through the remainder of the year.

And so I have a hard time ever suggesting that deposits are going to grow organically, plus 10%, on a regular basis, but we've been able to accomplish that last year and again, this year. I think if we go back to kind of the historical levels of mid- to low-single digits on organic deposit growth in the future. And certainly, there can be situations or opportunities where we can increase that level. But it's the reason we think of growing loans mid- to high-single digits, deposits at low to mid-single digits and replacing the difference over time in that liquidity gap with M&A.

Daniel Tamayo -- Raymond James -- Analyst

That's really helpful. I appreciate it. I'll step back. Thanks, guys.

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Thank you.

Operator

Our next question comes from Damon DelMonte from KBW. Please go ahead.

Damon DelMonte -- KBW -- Analyst

Okay. Good afternoon, everybody. And Mike, congrats on the retirement, and congrats to everybody else in their newly appointed roles.

Michael C. Rechin -- President and Chief Executive Officer

Thank you, Damon.

Damon DelMonte -- KBW -- Analyst

Sure. First question I had regarding capital and your outlook for that. Given the level of where shares are trading and given the strong capital levels you have, what are your thoughts on buybacks at this point in time?

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Well, we completed a buyback last year, and we felt like we achieved pretty good execution in this environment. With our shares where they are, we think it would be smart and opportunistic. We don't currently have a plan approved, but continuing discussions at the Board level.

Damon DelMonte -- KBW -- Analyst

Okay. And how about with regards to dividends? I think you noted that the payout is still less than 50%, would you consider increasing the dividend?

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Yes. We would definitely consider increasing the dividend. We just decided in this environment with some economic uncertainty, we've decided to leave it at $0.26 this year. But when -- we would likely make a move in May of next year, which would be our traditional second quarter decision.

Damon DelMonte -- KBW -- Analyst

Got you. Okay. And then, I guess with regard to the PPP forgiveness process, you noted that there was some submissions already in the fourth quarter. Do you expect to have this done by the end of 2021? Or maybe more so in the first half or the back half? Like how do you see the cadence of the forgiveness process?

Michael C. Rechin -- President and Chief Executive Officer

Yes. So the way I kind of look at it is we started in on the largest names, those greater than $50,000. So I suspect what will happen is it will probably be more front-end loaded to the year than it is back-end loaded to the year. With the ones less than $50,000 by number, kind of, submitted once we get that process from our -- the software vendor up and running. But the dollar should -- I would expect, be more front-end loaded to next year.

Damon DelMonte -- KBW -- Analyst

Got it. Okay. That's all I had. My other questions were asked and answered. Thank you.

Michael C. Rechin -- President and Chief Executive Officer

Thanks, Damon.

Operator

[Operator Instructions] Our next question comes from Brian Martin at Janney Montgomery.

Brian Martin -- Janney Montgomery -- Analyst

Hey, good afternoon. And congratulations everyone.

Michael C. Rechin -- President and Chief Executive Officer

Thank you.

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Thanks, Brian.

Brian Martin -- Janney Montgomery -- Analyst

Hey, just one question. One easy one for John. I mean you guys talked at length about, and thank you for all the credit details, John. Just, were there any changes in the special mention credit this quarter? I know you called out the classified. But any changes on that front of material note?

John J. Martin -- Executive Vice President and Chief Credit Officer

What I would say is that there's probably some, I don't have the actual criticized or special mention numbers in front of me. But what I'd say is there has been an increase in special mention, that being the transitional grade category. And as we move things into that category, we wait to see how the pandemic is going to affect our borrowers. And if it gets bad enough, we move them down to substandard. If not, we move them back up to past again. So there has been some migration into that category.

Brian Martin -- Janney Montgomery -- Analyst

Okay. So probably similar -- look at the similar level, like the classifieds or maybe a little bit more than what was gone into classified?

John J. Martin -- Executive Vice President and Chief Credit Officer

It will be incrementally more just because of the nature. You move those -- you're going to have more move into special mention, right, and then some are going to move down to substandard and then some will move back up in the past.

Brian Martin -- Janney Montgomery -- Analyst

Got you. Okay. Thanks, John. And maybe just one for whomever on the capital question. Just you talked about the dividends and the buyback. How about your appetite today or willingness to look at M&A today or just discussions, how those are playing out, if anything?

Michael C. Rechin -- President and Chief Executive Officer

I think there's been a benefit to this environment that while it hasn't been heavy, in what I would consider to be, Brian, genuine M&A discussions. There's been more bank-to-bank dialogue about all the uniqueness of this year than I can ever remember. So Mark and I have always kind of led the discussions with other banking companies, and that will clearly continue under Mark's leadership because we think we're very good at it, and we think there are companies that when paired with us, would make for a more powerful banking company. So our refreshed executive team have a keen eye for not only the organic strategy of this business, but opportunistic acquisition as well in any business. We -- it doesn't have to be limited to full banking companies.

Brian Martin -- Janney Montgomery -- Analyst

Do you feel like you need a little bit more clarity on the pandemic, Mike, before you engage in something? Or I guess that was really kind of the...

Michael C. Rechin -- President and Chief Executive Officer

I would say, yes. I mean, you heard John's answer a moment ago about the transitional nature of some of these clients working through this period. I feel like every bank is doing the same thing. So the answer would be yes. We'd love to have a little bit more settling before you go acquiring a bunch of loans you didn't originate.

Brian Martin -- Janney Montgomery -- Analyst

Yes. Got you. Okay. That's helpful. And just the last one for me was just on the -- as you guys look at kind of your comments about the budget, Mike and kind of stepping into next year, would your expectation be as you talked about the branch cuts that maybe you can hold on to the efficiency where it's at today, even in the low-rate environment? Or how are you thinking about just kind of the efficiency as you go into next year in the budgeting process?

Michael C. Rechin -- President and Chief Executive Officer

Yes, I think the acceptability of a budget for us, both at the senior management level and at the Board level is going to call for it to have a look-alike efficiency, absent any game-changing technology investments we make. But no, it's -- I think our stripes around that topic of efficiency are going to remain the same.

Brian Martin -- Janney Montgomery -- Analyst

Yeah. Okay. Perfect. That's all I had, guys. Thanks.

Michael C. Rechin -- President and Chief Executive Officer

Thanks, Brian.

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Thanks, Brian.

Operator

Next, we have a follow-up question from Scott Siefers from Piper Sandler. Please go ahead.

Scott Siefers -- Piper Sandler -- Analyst

Hey. Thanks, guys.

Michael C. Rechin -- President and Chief Executive Officer

Sure.

Scott Siefers -- Piper Sandler -- Analyst

A couple of follow-ups related to credit. So I guess, Michele, just in looking at what the reserve will look like post-CECL. If we are in that kind of 2%-ish range that's going to compare very, very well relative to a number of your peers. I guess, just curious on the thinking behind the need for even modest additional reserve build. Is that just kind of an abundance of caution given the uncertainty or any color there? And then as a follow-up to that, John, none of us really knows where this credit cycle is going to go. But losses have stayed very low, I think, for longer than most of us would have thought as all the stimulus works through. So this quarter, absent the single credit that you talked about, it looks like charge-offs would have been pretty negligible. I guess I'm just curious as to your sense for the evolution of loss migration in this cycle. When will things pick up more materially?

John J. Martin -- Executive Vice President and Chief Credit Officer

You want to go first, Michele?

Michele M. Kawiecki -- Senior Vice President And Director Of Finance

Sure, I'll go first, yes. Scott, I mean, I think you just nailed it. It really isn't an abundance of caution. I mean you've heard John talk about our credit portfolio. There isn't anything in our credit portfolio that is spooking us to think that we need a large reserve. We, just like anybody else, don't know exactly what the depth of this is -- the impact is going to be on our customers nor when the loss emergence periods will really emerge. But we want to be ready, and we feel like having abundance of reserves is a good place to be for a place of safety.

Scott Siefers -- Piper Sandler -- Analyst

Yeah. Okay. Thank you.

John J. Martin -- Executive Vice President and Chief Credit Officer

Yes. And then, Scott, just with respect to your question, built into some of the reserve building in the first two quarters were specific reserves. So when you look at and you think about what happened in that second quarter, part of what we charged off in this quarter was put in there in that quarter, in the second quarter. And so when you look forward to quarters and you look for, I'll say, loss emergence out of some of these names that have specific reserves in it and you look at that line, you can kind of see now, I would say, for the $14.1 million loan that we just put in, the nonaccrual, it's got a $3.1 million or a little bit -- a little over $3 million specific reserve on it.

So that will eventually charge out. But beyond that, the specific reserves tail off pretty significantly there. So having visibility into the future on a name-by-name level or at a name-by-what-name level, there isn't a lot that I see today. And to track it beyond that, it's really just, in my view, to look at where are the classified assets going and directionally, what does that tell you about potential future losses. I don't know that helps you, but that's kind of how I think about it.

Scott Siefers -- Piper Sandler -- Analyst

Perfect. All right. Thank you very much.

John J. Martin -- Executive Vice President and Chief Credit Officer

Thank you, Scott.

Operator

This concludes our question-and-answer section. I would like to turn the conference back over to Mike Rechin for closing remarks.

Michael C. Rechin -- President and Chief Executive Officer

Thank you, Emily. I really don't have any. I appreciate the quality of the listening to the First Merchants story. As you can tell, we're looking forward to finishing strong in 2020, getting off to a fast start with our leadership team here next year, and look forward to talking to you in a couple of months. Thank you.

Operator

[Operator Closing Remarks]

Duration: 62 minutes

Call participants:

Michael C. Rechin -- President and Chief Executive Officer

Mark K. Hardwick -- Executive Vice President, Chief Financial Officer and Chief Operating Officer

Michele M. Kawiecki -- Senior Vice President And Director Of Finance

John J. Martin -- Executive Vice President and Chief Credit Officer

Scott Siefers -- Piper Sandler -- Analyst

Terry McEvoy -- Stephens -- Analyst

Daniel Tamayo -- Raymond James -- Analyst

Damon DelMonte -- KBW -- Analyst

Brian Martin -- Janney Montgomery -- Analyst

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