First Merchants Corporation (NASDAQ:FRME) Q3 2023 Earnings Conference Call October 26, 2023 11:30 AM ET
Company Participants
Mark Hardwick – Chief Executive Officer
Mike Stewart – President
Michele Kawiecki – Chief Financial Officer
John Martin – Chief Credit Officer
Conference Call Participants
Terry McEvoy – Stevens
Damon DelMonte – KBW
Nathan Race – Piper Sandler
Brian Martin – Janney
Operator
Thank you for standing by. Welcome to the First Merchants Corporation Third Quarter 2023 Earnings Conference Call. Before we begin, management would like to remind you that today’s call contains forward-looking statements with respect to the future performance and financial condition of First Merchants Corporation 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 unquantitative information to be discussed today as well as reconciliation of GAAP to non-GAAP measures.
At this time, all participants are in a listen-only mode. After the speakers presentation there’ll be a question and answer session. [Operator Instructions]. As a reminder, today’s call is being recorded.
I will now turn the conference over to you host, Mr. Mark Hardwick, CEO. Mr. Hardwick, you may begin.
Mark Hardwick
Good morning, and welcome to First Merchants’ third quarter 2023 conference call. Valerie, thanks for the introduction and for covering the forward-looking statement on page 2.
We released our earnings today at approximately 8 a.m. Eastern Standard Time. You can access today’s slides by following the link on the third page of our earnings release. On page three, you’ll see today’s presenters and our bios to include President Mike Stewart, Chief Credit Officer, John Martin, and Chief Financial Officer Michele Kawiecki.
On page four, you will see a map representing the geographic locations of our 118 banking centers, as well as a few financial highlights as of 9/30/2023. We also received two more Comparably Awards during the quarter, including Best Places to Work for Career Growth and Best Places to Work for Women, which I’m really proud of, so we did include those on page four.
Now, turning to slide five, I’m pleased to report that our performance remains healthy and strong, and our teams continue to meet the demands of our communities and our client base.
We reported Q3 2023 earnings per share of $0.94 per share compared to $1.08 per share in the third quarter of 2022. Net income totaled $55.9 million for the quarter, producing a return on tangible common equity of 16.54% and a return on assets of 1.24% for the quarter.
During the quarter, our deposits increased by $65.4 million, or 1.8%. The core results were even better as we decreased brokered deposits by $133.6 million and municipal deposits by $128.8 million.
The adjusted growth of $327.8 million and traditional, commercial, and consumer deposits was very strong and positioned us well for the coming quarters and expected growth.
Loan yields remain strong, reflecting a highly variable portfolio, increasing to 6.58%. New and renewed loan yields totaled 7.88%, up 58 basis points over the second quarter of this year.
Our efficiency ratio remains strong in the low 50s, and our allowance for credit losses is still 1.67%, despite the meaningful charge-off due to a customer fraud that we will discuss later in the call.
Year-to-date, we’ve earned $179.9 million, or $3.03 per share, and we remain committed to our guidance of mid- to high-single-digit loan growth at the top quartile performance metrics.
Now, Mike Stewart will provide more insight on loans and deposits.
Mike Stewart
Yes. Thank you, Mark, and good morning to everybody. Our business strategy that’s outlined on slide six remains unchanged. And as a reminder that the financial results we deliver represent the durability of our business model within the primary markets of Indiana, Michigan, and Ohio.
We serve the diverse locations that are both in stable rural markets and in growing metro markets, and we’re a commercially-focused organization across all these business segments. The Collective First Merchants team is actively engaged within all of our business communities, and the offerings listed on this page represent the solutions we deliver.
Throughout 2023, we’ve remained committed to our business strategy, organic growth of loans and deposits and fee income, attracting, retaining, and building our team, investing in technology platforms that enhance service, and delivering top-tier financial metrics.
If you turn to slide seven, the map on the left side of the page offers a breakdown of the third-quarter loan and deposit portfolio by state, with the right side highlighting loan and deposits that’s by our primary business segments.
The annualized total loan growth for the third quarter was on the lower end of my expectations as our commercial clients aggressively managed their working capital positions.
Line of credit utilization actually reduced in the quarter, and clients slowed or delayed some of their capital outlays or projects as they continued to evaluate the current interest rate environment.
Year-to-date, our total loan portfolio has grown on an annualized rate of 4.6% when adjusting for the second-quarter loan, so we talked about last quarter. And as the earnings release stated, our loan portfolio is growing 6.4% over the last 12 months.
As Mark said, mid-single-digit growth rate remains the expectations moving forward as the commercial loan pipeline ended September at the highest level we’ve seen in the past year.
Moreover, October has already shown the benefits from the third-quarter pipeline delays that have now closed. John Martin has a slide, page 18, that highlights the year-over-year growth within the portfolio, and that slide reflects that nearly 65% of our loan growth comes from the commercial segment.
In overall, our commercial represents over 75% of our total loan portfolio with the balance coming from the consumer segment. That segment’s comprised of residential mortgage, HELOC installment, and the private banking relationships.
And as you can see, during the third quarter, that segment grew had a 7.3% annualized rate. Overall, the commercial segment continues to be the loan growth engine of the bank, and we continue to get higher spreads on the new loan generation.
Michele will highlight loan yields next, but within the investment real estate segment, spreads continue to widen up to 75 basis points on similar risk profiles from the second half of 2022. And the C&I space spreads are widening up to 25 basis points with a strong emphasis on relationship strategies, both deposits and fees.
The overall economic environment, inclusive of the competitive landscape, the competitive landscape with super regional banks in particular, affirms my expectation of single-digit loan growth with improving loan yields through the balance of 2023 and into 2024 with the commercial group driving a bulk of that.
Our balance sheet is positioned for that growth. Our team is positioned for that. And our underwriting remains consistent and disciplined across all those segments. So if you think about the deposits that you see on that page, deposits grew 1.8% on an annualized rate during the third quarter and 2.4% year-to-day.
As you heard Mark discuss from slide five, the commercial deposits were actually muted. The growth was actually muted by the seasonal decline of the municipal fund space, seasonally paying down about $128 million.
So set differently, the rest of the commercial-related deposit base grew 5% during the quarter when adjusting for those municipal fund declines. The consumer deposit segment showed strong growth at over 9% annualized for the quarter. And this growth includes the activity through both the branch network and through our private banking team.
So the continued deposit growth throughout 2023, throughout the bank failures earlier this year, throughout the continued Fed rate increases, supports our ability to remain focused on home growth.
So I’m going to turn the call over to Michele, and she can review more of the detail of the balance sheet and the income statement drivers.
Michele Kawiecki
Thanks, Mike. Slide eight covers our third quarter results. Lines one through five show the balance sheet changes for the quarter. Mike covered our loan and deposit growth in his remarks.
You can see on line three, investments declined by $177.8 million this quarter. We sold $33.2 million of bonds during the quarter, and scheduled paydowns and bond maturities accounted for another $38.2 million of the decline. The remainder of the decline was due to the change in valuation of available-for-sale securities.
Pre-tax, pre-provision earnings totaled $67.4 million this quarter. Pre-tax, pre-provision return on assets was 1.48%, and pre-tax, pre-provision return on equity was 12.51%, all of which reflect strong profitability metrics.
Slide nine shows the year-to-date results. Loans have grown $627 million year-over-year, which was funded by the deposit growth of $212 million and proceeds from the investment portfolio sales and scheduled cash flows.
Year-to-date pre-tax, pre-provision earnings totaled $214.3 million. Pre-tax pre-provision return on assets was 1.58%, and pre-tax, pre-provision return on equity was 13.44% year-to-date.
The tangible common equity ratio increased from 6.66% in prior year to 7.69% at September 30th, reflecting that strong year-to-date earnings growth. And tangible book value increased $3.17 over prior year.
Details of our investment portfolio are disclosed on slide 10. The sale of $33 million of bonds this quarter resulted in a loss of $1.7 million. Year-to-date, we have sold $347 million in bonds, creating liquidity to put to work in the loan portfolio and ensure we have a solid cash position.
Expected cash flows from scheduled principal and interest payments and bond maturities for the next 15 months totals $335 million. Slide 11 shows some details on our loan portfolio.
As Mark mentioned in his opening remarks, new loan yields increased 58 basis points to 7.88%. $8.1 billion of loans, or 66% of our portfolio, are variable rate, with 37% of the total portfolio repricing in one month and 53% of the total portfolio repricing in three months.
Through the end of 2024, we have $1 billion in fixed-rate loans maturing, which is a quarter of our total fixed-rate loans portfolio, with a weighted average maturity of 4.64%, providing good incremental interest income given new loans are repricing at 7.88% currently.
The allowance for credit losses on slide 12 declined from 1.8% to 1.67% of total loans due to net charge-offs incurred during the quarter of $20.4 million, which John will provide details on in his remarks.
We recorded $5 million of provision for credit losses on loans, which was offset by a reduction of reserves for unfunded commitments of $3 million due to a decline in unfunded commitment balances. The result was net provision expense of $2 million recognized in the income statement.
Slide 13 shows details of our deposit portfolio. We continue to have a strong core deposit base, with 41% of deposits yielding five basis points or less. Our non-interest bearing deposits were 17.4% of total deposits at the end of the quarter, which is down slightly from 18.1% in the prior quarter.
Our total cost of deposits increased 33 basis points to 2.32% this quarter, and our interest-bearing deposits cycle to date beta at quarter end was 51%, which was up from 47% last quarter.
The big picture of what we’re seeing is customer interaction in deposit pricing is lessening, so the mixed shift and beta increases slowed this quarter compared to last, leading us to believe that we’re getting closer to achieving deposit price stability.
Although we expect the cost of deposits to continue to increase somewhat through the remainder of the year, we expect that pace will be even slower than what we experienced this quarter.
On slide 14, net interest income on a fully tax-equivalent basis of $139.3 million declined $4.4 million from prior quarter. Earning asset yields increased 19 basis points this quarter as shown on line five, and was somewhat offset by the increase in funding costs on line six, reflecting stated net interest margin on line seven of 3.29%, a decline of 10 basis points from prior quarter.
Average deposits during the quarter were $89 million higher than the period ending balance, and given we had muted loan growth this quarter, the impact put a bit of pressure on margin.
Non-interest income on slide 15 increased $1.5 million, driven primarily by $1.9 million increase in gains on the sales of mortgage loans. We originated $192 million of mortgage loans this quarter, and held roughly 30% of those for investment and sold the rest in the secondary market.
Our gain on percentage, including servicing income, was 2.9%, so our mortgage team was able to contribute some meaningful fee income this quarter. Moving to slide 16, we continue to demonstrate good expense management, with total expenses for the quarter of $93.9 million, an increase of $1.3 million over last quarter. The increase was primarily due to higher marketing costs this quarter.
Our efficiency ratio continues to be low, coming in at 53.91% for the quarter and 52.6% year-to-date. Slide 17 shows our capital ratios. Our strong earnings growth this quarter drove capital expansion in all ratios with the exception of the tangible common equity ratio, which declined 30 basis points, totaling 7.69%, due to the impact of AOCI that I mentioned earlier in my remarks.
Heading into the remainder of 2023, we feel great about the capital position, the strength in our balance sheet, and are pleased with the sources of our growing liquidity coming from customers that enhance franchise value.
That concludes my remarks, and I will now turn it over to our Chief Credit Officer, John Martin, to discuss asset quality.
John Martin
Thanks, Michelle, and good morning. My remarks start on slide 18. I’ll highlight the loan portfolio, touch on the expanded insight slide, review asset quality and the non-performing asset role for before turning the call back over to Mark.
So turning to slide 18, on line two, commercial industrial loans originated by our sponsor finance group grew in the quarter by $31 million, or 15% annualized, while construction loans grew $72 million, or 30% annualized. From a macro perspective, other lines of business offset this growth with total loans ending mostly unchanged in the quarter. We continue to see activity in sponsor finance lending where we’ve maintained consistent underwriting and continue to see stable to marginally improving spreads. Higher interest rates are driving additional capital contribution requirements to meet our underwriting and stress criteria.
Moving down to line nine, we slowed balance sheet growth of Resi one to four family mortgages with $10 million added to the portfolio for the quarter. We completed the origination transition strategy in the second quarter, which has essentially stopped portfolio growth and increased sale and servicing income, which Michelle just mentioned.
Turning to slide 19. We’ve updated the portfolio insight slide to provide additional transparency. In the commercial space, the C&I classification includes sponsor finance as well as other, as well as owner-occupied, CRE, associated with the business. Our C&I portfolio has a 20% concentration in manufacturing. Our current line utilization remain consistent around 41%, as Stew just mentioned, with line commitments increasing $32 million.
We participate in roughly $644 million of shared national credit across various industries. These are generally relationships where we have access to management and revenue opportunities beyond the credit exposure.
In the sponsored finance portfolio, I’ve highlighted key credit portfolio metrics. There are 86 borrowers of which fixed charge coverage exceeds 1.5 times based on the June financial data. Although this has trended lower with higher borrowing crest, it remains healthy with current classified loans at 2.7% as compared to 3.8% the prior quarter. This portfolio generally consists of single bank deals for platform companies and private equity firms, not large, widely syndicated leveraged loans. We review the individual relationships quarterly for changes in borrower condition, including leverage and cash flow coverage.
Turning to slide 20, we continue to provide the breakout of our non-owner occupied commercial real estate portfolio with additional detail around our office exposure. Office exposure is broken out on the bottom half of the chart and represents 2.1% of total loans unchanged from the prior quarter with the highest concentration outside of general office in medical. I’ve added a chart to the bottom right with office portfolio maturities.
Refinance risk appears low with $16.5 million or 6.4% of total office loans maturing within the next year. I also provided a couple of bullets to provide additional color into the office portfolio and its granularity with a portfolio of 219 loans in an average balance of $1.2 million. The office portfolio is well diversified by tenant type and geographic mix. We continue to periodically review our larger office borrowers and view the exposure as reasonably mitigated through a combination of loan-to-value guarantees, tenant mix and other considerations.
On slide 21, I highlight our asset quality trends and current position, NPAs, and greater than 90 days past due loans decreased $17.6 million or 14 basis points on line 5. We had two commercial relationships which made up the $19 million of the $20 million of charge-offs for the quarter. I spoke to both borrowers last quarter when they were moved to nonaccrual. The first, the $14 million charge-off, resulted from the previously disclosed commercial loan that was downgraded to non-performing in the second quarter. This occurred when we received a report from the lead bank of an alleged fraud by a borrower in which we jointly participated.
The syndication included three banks where First Merchants was not the lead. An agent for the borrower had allegedly both sold and pledged the bank’s group’s collateral out of trust. The balance was charged down based on the alleged fraud and findings uncovered during the lead bank’s ongoing investigation and subsequent bankruptcy filings by our borrower and its agent. We continue to monitor the bankruptcy process and pursue opportunities for recovery. The second $5.3 million charge-off was driven by a pullback in industrial construction as segment of the market in which the borrower focused and inability to adjust expenses.
Moving down to slides, moving down to our slide seven, classified loans declined 1.89% of loans resulting from both the charge-offs as well as an improvement in asset quality. Moving on to slide 22, where I’ve again rolled forward the migration of non-performing loans, charge-offs, or E and 90 days past due. For the quarter, we added non-accrual loans on line 2 of $7.5 million, a reduction from payoffs or changes in accrual status of $2.5 million on line 3, and a reduction from gross charge-offs of $20.9 million then dropping down to live eleven ninety days past due decreased three hundred thousand dollars which resulted in NPAs and 90 days past due ending at $17.6 million for the quarter.
So just to summarize, asset quality remains good. When I exclude the impact of the third quarter borrower with alleged fraud, Q3 net charge-offs would have been an annualized 22 basis points of total average loans for the quarter. And when looking at year-to-date net charge-offs, it would have been an annualized 10 basis points. Both criticized and classified loans remain in check and delinquency remains stable. All in all, we’re ending the quarter with good asset quality metrics.
I appreciate your attention, and I’ll turn the call over to Mark Hardwick.
Mark Hardwick
Great, thanks, John. Hey, slides 23 and 24, they just highlight some of our 10-year combined annual growth rates and returns, and then slide 25 is a reminder of our vision, mission, and our team statement, along with some strategic comparatives.
But at this point, I’d love to get into the Q&A portion of the call.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Terry McEvoy of Stevens. Your line is open.
Terry McEvoy
Hi. Thanks. Good morning, everyone. Maybe start with a question for Michelle. Could you just maybe talk about the repricing of certain assets as well as just, ongoing increases in funding costs and what does that mean to your thoughts for the near-term margin and when and where it might bottom?
Michele Kawiecki
Good morning, Terry. Our September, so our quarterly margin was 329. Our September margin was 325. So we do think we’ll see a bit more margin compression in Q4. And we are still working through our planning for 2024, although I would expect either Q4 or Q1 of 2024 to really see our margin trough. And then with the re-pricing of the assets that we expect to see through the remainder of 2024. We should be able to see a little pickup in margin, but we’ll finish our planning and we’ll be able to provide a little bit better guidance to you, I think, next quarter.
Terry McEvoy
Thank you. And maybe as a follow-up question for John, first off, thanks for all the details into the loan portfolio. But my question is how do the underlying credit trends within the shared national credit portfolio, how does it differ at all from the rest of the C&I portfolio, just given there’s been a fair amount of concerns with SNCC loans? And are you seeing anything different between your kind of core C&I business?
John Martin
Yes, I’m really not that the shared national credit portfolio, we’re underwriting it kind of the same standard. We’re not kind of we are running it underwriting it to the same standard. And really, the difference is the size of the size of the credit itself. So frankly, there hasn’t been a material difference between the two portfolios. If anything, it’s probably performing maybe marginally better than the rest of the portfolio.
Mark Hardwick
We’re also seeing some of the expansion in the margin, expansion in the loan yields.
Terry McEvoy
Yes. Understood. Thank you. And I guess one small one, the auto suppliers or auto parts manufacturers, it was on one of these slides, just given the prolonged strike or potential of a prolonged strike, what’s the size of that portfolio? Were there any other write downs and do you have any other observations there?
John Martin
Yes, it’s interesting, Terry. I, when I started reaching, researching for the quarter, I tried to get to the automotive portfolio and when I think about manufacturing, there’s so much in the Midwest that’s tied to auto and, and somehow otherwise related to it. But it’s, it’s some fraction of that manufacturing total. It’s hard to pull out, what is directly to your, two-two if you will, because we’re not really doing Tier 1 suppliers to the automotive industry, but, it’s — it’s some, I’ll say significant. I will say that, to date, most of the changes that, or the adjustments that manufacturers have made have been relatively minor, production still occurs at most of the plants and we haven’t seen any direct, widespread impact from either the slowdowns or some of the plant shutdowns that have occurred.
Terry McEvoy
Right, thanks for taking my question.
John Martin
Yes, I would say, though, that if it does, if it were, months, months of it, it will obviously have some impact. But right now it’s been kind of isolated.
Terry McEvoy
Thank you.
Operator
Thank you. One moment, please. Our next question comes from the line of Damon DelMonte of KBW, your line is open.
Damon DelMonte
Hey, good morning, everyone. Hope everybody’s doing well today. Just wanted to start with –
Mark Hardwick
Good morning, Damon.
Damon DelMonte
Hey, Mark, just wanted to start with Michelle on a question on expenses. If you could just give us a little perspective on kind of your thoughts here in the fourth quarter and more so as we go through 2024, as far as kind of a quarterly outlook for the overall expense base?
Michele Kawiecki
Hey, good morning, Damon. For Q4, I would say the expense run rate will be probably be in the $94 million to $95 million range, which is really consistent with the guidance that we have provided last quarter for 2024. We’re still working through our planning, as I mentioned to Terry, and so we’ll be able to give you a better run rate probably next quarter to what we’ll see in 2024.
Damon DelMonte
Got it. Okay. Thanks. And then on the fee income side of things, obviously a little bit more in the mortgage banking, I think this quarter, probably some seasonality here in the fourth quarter, but do you think kind of a call it $28.5 million and $29.5 million ranges is reasonable as we close out the year?
Michele Kawiecki
I think that our run rate, what we had in Q3 would be a good run rate to use for Q4.
Damon DelMonte
Okay. All right, great. And then I guess lastly on that tax rate, do you have an estimated effective tax rate we should consider?
Michele Kawiecki
Yes, I think we’re expecting it to be 15% to 15.5%
Damon DelMonte
Okay. That’s all I have for now. I’ll step back. Thank you.
Michele Kawiecki
All right, thanks Damon.
Operator
Thank you, one moment please. Our next question comes from the line of Nathan Race of Piper Sandler. Your line is open.
Nathan Race
Yep. Great. Hi everyone. Hope everyone’s doing well. Just going back to the margin outlook over the next few quarters, curious to kind of hear some thoughts on some of the dynamics on the right side of the balance sheet. It was great to see the borrowings held flat versus the last quarter. So just curious how you guys are thinking about kind of core deposit growth going forward and how you are thinking about funding loan growth. It sounds like mid-scale digits, loan growth should be restored going forward. So I imagine it’s just a combination of securities portfolio cash flow, though, Michele alluded to earlier, and then also with some incremental deposit growth. Is that the right way to think about it?
Mark Hardwick
Yes, it is. I think, and good morning, Nate. I think we’re pretty confident in our ability to continue to grow our deposit base to fund our loan growth. And so that mid to higher single digit growth rate of loans for next year, funded primarily out of deposits is what we’re focused on.
Nathan Race
Okay, great. And then just kind of theoretically in a higher-for-longer rate environment, do you guys have any visibility in terms of kind of how you think about, where NII maybe bottoms and just maybe an overall growth rate for next year?
It looks like you’re on pace to grow NII 4% to 5% this year. So any thoughts on just how NII trajects into next year under that environment?
Michele Kawiecki
Well, I think in Q4 with the margin compression that we think we might see, at least a bit of it that we think we’ll see, there could still be some pressure on net interest income. I think once we hit that trough, though, and we make a turning point, then we should be able to see some growth. And I think the loan growth that we’ll expect to see over the coming quarters will also help offset any rising deposit costs that are left until we see some real deposit pricing stability.
Nathan Race
Okay, great. Makes sense. And then maybe just lastly on capital. You guys are still operating with pretty flexible excess capital levels. So just curious to hear any thoughts on perhaps reengaging buybacks or the plan kind of just to build capital, just given the uncertainty out there?
Mark Hardwick
Yes. I’d love to be more active in the market with buybacks. We haven’t felt like that it’s been the right time to do that. And what we’d like to just see is stability at our tangible common equity level above 8% and some certainty around the marketplace that we’ll have less volatility.
Nathan Race
Got it. So it still sounds like maybe M&A is kind of off the table at least through the first half of 2024. Is that a fair way to characterize kind of the prospects there?
Mark Hardwick
Yes. At this point in time, we are 100% focused on internal projects. We’re really excited about getting Q2 deployed. Our online and mobile platform for all of our customers, consumer and commercial, and also getting our SS&C project completed, which is a complete replacement of our private wealth platform. So that’s the priority at this point. And the trading multiples, I really don’t lend to M&A activity. And so, we’re continuing to keep our relationship strong with banks that we’re impressed by that may be potential candidates in the future. But I don’t really feel like we have the pricing power to be active at this point, nor are we ready internally to focus on M&A.
Nathan Race
Got it. Makes sense. I appreciate all the color that you guys taking the questions.
Mark Hardwick
Thank you.
Operator
Thank you. One moment please. Our next question comes from the line of Daniel Tamayo of Raymond James. Your line is open. Pardon Mr. Tamayo, your line is open. One moment, please. Our next question comes from the line of Brian Martin of Janney. Your line is open.
Brian Martin
Hey, good morning, everyone.
Mark Hardwick
Good morning, Brian.
Brian Martin
Hey, Mark. Just maybe one question, Michele, on the margin. Just the spot margin for the month of September. How did it trend throughout the quarter? Just trying to get a feel for that based on kind of the slowing deposit costs here?
Michele Kawiecki
I think it trended down pretty rapidly, actually. And so it ended up landing at 325 at the end of September.
Brian Martin
Okay. And I guess your commentary, but with the deposit costs slowing and kind of the what you outlined as far as this fixed rate loans are repriced. I mean, I guess your expectation is that the loan yields continue to expand here in the next three to four quarters just given that repricing that’s occurring, and along with. I mean, that’s kind of the message with the kind of stabilization you’re seeing in the funding side?
Mike Stewart
Yes. That’s Mike Stewart. I do think that seeing it on the commercial side, the mortgage that we put on would be the same way. So, yes, and the repricing and any I think we’re doing in the HELOC, all that should drive higher loan yields.
Brian Martin
Okay. And as far as when that may trough, I mean, if the deposit costs are close to troughing, I mean, we’re at least three to four quarters out as far as that remix or that, the benefit coming through on that on those loan yields given what you’re seeing today.
Mike Stewart
Yes. I mean, our models show, if rates stay steady where they are, that we’ll continue to see increases through all of 2024.
Brian Martin
Yes. Okay, perfect. And then appreciate all the color and credit. Just as far as kind of the reserves and actually kind of recording a provision this quarter, just kind of how to think about that in the context of where credit’s at. Obviously, you’re pretty good outside of the one fraud [ph] situation this quarter, but just any thought on how we should think about modeling that or projecting going forward, given the credit environment?
Mike Stewart
Yes. I think from a provision expense perspective, it’s going to be a replacement, kind of a trading dollars on a replacement side, meaning that we’ll provide for charge offs with potentially some release in the ACL. As far as charge-off scale, I think we’ve given guidance in the past of those being between 10 and 20 basis points a quarter.
Brian Martin
Okay. And just your thought, John, on the — as far as credit goes, kind of,
you talked about this next being pretty good, maybe better than the other portfolio. But just within the traditional portfolio, where are the concerns? I mean, we’ve seen a handful of other banks have some issues this quarter and just kind of ongoing, but if you look to your portfolio, as far as where the greater, I guess what you’re maybe more mindful of today, looking, paying more attention to. Can you give us any thoughts there?
Mike Stewart
Yes. Brian, when I think about potential impacts from higher rates, I think about it in the construction portfolio, just because what you underwrote to and the appraisals that you had potentially up front are going to necessarily drive tighter cash flow coverage. When I think about the broader portfolio, across the spectrum within the commercial loan portfolio, we underwrite, we stress, we do multivariable stress tests up front on our C&I borrowers. And so, there’s not one particular portfolio that I’m looking at that concerns me maybe more than another.
But even in the construction portfolio, and as we add new names, those are requiring additional capital, as I mentioned in that portion of my speech, Brian, around the sponsor finance portfolio. The things we’re underwriting today, I feel pretty good about because they have the higher interest rates already built into them. So I don’t know if that answers your question. I wish I could say it was this portfolio or that portfolio. But generally speaking, to this point, absent the, and I’m not going to use the word idiosyncratic. But the fraud event that occurred, I– maybe construction, but that would be it.
Brian Martin
Okay. And getting the renewals today on some of these credits, the commercial real estate credits, has that been a problem, given the increase in rates that are coming into these folks? Or I guess, has that been, those loans really are getting renewed without an issue at this point today?
Mark Hardwick
Well, what happens, Brian, at some level is that when you have a construction project, you’ve got a conversion covenant or requirement that they need to meet. And in order for them to move to the secondary market and with higher short-term rates, the way we measure it on short-term rates, it’s tighter. And so, we’re requiring at maturity a number of different strategies, but one is potentially additional capital being put in, maybe marginal right sizing, maybe additional guarantees, additional collateral. But from a extend and pretend, as the industry, my colleagues like to say, it’s more just a strategy around what to do when interest rates maybe are challenging on a particular project.
Brian Martin
Got you. Okay.
Mike Stewart
And I think it’s safe to say most. I just jump in, it’s safe to say most of those loans aren’t going through a renewal process. They’re moving into secondary markets.
Mark Hardwick
Those are strategies we would employ if we needed to, but to date we’re not necessarily seeing any of that, right?
Mike Stewart
Right.
Mark Hardwick
And on a renewal, renewal specific, if I’m understanding your question, something that might have had a renewal after three or five years, borrowers have had the opportunity to increase rental rates and change the dynamics of an individual project or an individual property. So we haven’t seen issues necessarily related to a borrower’s inability to get renewed as a result of the higher interest rates.
Brian Martin
Yep. No, I appreciate it. I was really talking about the commercial real estate, not construction. But I appreciate all the commentary on it and just trying to understand that. So, but thank you for taking the questions.
Mark Hardwick
Yes.
Mike Stewart
Valerie, I assume, does that conclude the Q&A portion?
Operator
Mr. Tamayo had a question, but his line may be muted. Okay. So that does conclude our Q&A portion. I’d like to turn the call back over to Mr. Hardwick for any closing remarks.
Mark Hardwick
Great. Thanks, Valerie. I hope you can hear the confidence that we have in our business model. Our margins are healthy. Our capital is strong. Our efficiency is in top quartile kind of performance range. And more importantly, we’re confident that we will continue to achieve our growth rates for both loans and deposits into the future.
And if we do that, we’re taking care of the needs of the community that we serve and likely taking care of all of our stakeholders. So, we appreciate your time today. We appreciate your investment and interest in First Merchants. Look forward to talking to you soon.
Operator
Thank you. Ladies and gentlemen, this does conclude today’s conference. Thank you all for participating and have a great day. You may all disconnect.
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