First Merchants' CEO Discusses Q4 2013 Results - Earnings Call Transcript

Jan.28.14 | About: First Merchants (FRME)

First Merchants Corporation (NASDAQ:FRME)

Q4 2013 Earnings Call

January 28, 2014 2:30 p.m. ET

Executives

Michael Rechin - President & CEO

Mark Hardwick - CFO

John Martin - Chief Credit Officer

Analysts

Scott Siefers - Sandler O'Neill & Partners

John Barber - KBW

Stephen Geyen - D.A. Davidson

Brian Martin - FIG Partners

Daniel Cardenas - Raymond James

Operator

Good afternoon and welcome to the First Merchants Corporation Fourth Quarter 2013 Earnings Conference Call. All participants will be in listen-only mode. (Operator Instructions). After today's presentation, there will be an opportunity to ask questions. (Operator instructions) Please note this event is being recorded.

We will be using user control slides for our webcast today. Slides maybe viewed by following the URL instructions noted in the First Merchants news release dated Tuesday, January 28, 2014, or by visiting the First Merchants Corporation shareholder relations website and clicking on the webcast URL hyperlink.

During the call, management may make forward looking statements about the company's relative business outlook. These forward-looking statements and all other statement made during the call that do not concern historical effects are subject to risk and uncertainties that may materially effect actual results. Specific forward-looking statements include, but are not limited to, any indications regarding the financial services industry, the economy and future growth of the balance sheet or income statement.

I would now like to turn the conference over to Mr. Michael Rechin, President and CEO. Mr. Rechin, the floor is yours, sir.

Michael Rechin

Thank you, Mike. Welcome everyone to our earnings conference call and webcast for the fourth quarter ending December 31, 2013. Joining me today as always are Mark Hardwick, our Chief Financial Officer, and John Martin, our Chief Credit Officer.

We released our earnings, I hope you have them, in a press release at approximately 10:30 Eastern Daylight Savings Time earlier today. And our presentations speak to the material from that release. The directions that point to the webcast are also contained in the backend of that release and my comments will begin on Page 4 on a page titled First Merchants 2013 Performance.

So I thought I would speak to both what I view as our highlights for the full year and then touch on the fourth quarter before I look to my colleagues to provide some of the detail of both the results as it relates to the financials and then some of the credit metrics behind those results.

As I said, in the press release, we reported that First Merchants had earned 2013 record net income available to common shareholders of $42.2 million compared to $40.6 million that we earned in 2012.

Full year 2013 earnings per share totaled $1.41 identical to 2012. And as you can see in the release, we got to $1.41 in a different way. In 2012, our results included a one-time $9.1 million or $0.21 per share gain associated with the FDIC purchase of Shelby County Bank, whereas in 2013 that same $1.41 total was after recognizing the expenses with bringing in important acquisition into our company by way of Citizens Financial. And the expenses associated with that roughly $5.4 million of one-time expenses are included in those earnings which were heavy in the fourth quarter as we got to a close. We're pleased with that.

Other highlights for the year in my mind are a improvement in our overall capital structure, I thought we had a effective debt transaction that closed November 1 issuing $70 million which was a combination of $5 million in senior debt, $65 million in sub-debt that effectively refinanced what had been our subordinated debt and fully redeemed our remaining small business lending fund shares into a new 15-year sub-debt financing, replenishing our level of tier-2 capital.

Earlier in the year, we through strength of earnings all through 2012 into the early part of the year, our board choose to increase the common dividend from $0.03 to $0.05 per share. So I think for our shareholders it proved to a good year. Our market cap between the performance, the acquisition, the shares that were issued as a result of the acquisition, our shares grew from $14.84 at the beginning of 2013 ending at $22.70. And our market cap as the bullet point on this slide shows grew 90% from roughly $430 million to $850 million. So we're pleased with a lot of that activity.

The fourth quarter is highlighted on the bottom of this page and highlighted throughout the release where we earned $11.2 million in net income versus $9.2 million in the like period fourth quarter of 2012, $0.34 in the current period versus $0.32 a year ago. And included, as I referenced earlier, the bulk 80% of our acquisition expenses $4.5 million, which Mark will speak to, included in that $11.2 million current period result.

Spent months of collaboration, culminating in our November 12 closing having received all the necessary approvals to bring the Citizens franchise into First Merchants and begin the next chapter of our company’s history. We're pleased and I think we talked about at the last earnings call the kind of consistent view of the asset quality that we saw coming from Citizens balance sheet and their loan portfolio and an investment portfolio. Took six months roughly to close, we spent significant amount of time with our new colleagues in the portfolio. Our view at closing and now is that in the transaction -- the transaction pricing very appropriate as a value for our shareholders.

Fourth line item is that while the Citizens acquisition and the closing was a high priority the balance of the company stayed focused on the market and our clients. We had our strongest loan growth quarter of the year in the fourth quarter 3.5% on a standalone basis just over that. We are pleased to see that our clients continue to look for First Merchants for solutions.

At this point, I’m going to turn the program over to Mark to dig a little bit deeper into the financial results.

Mark Hardwick

Thanks, Mike. My comments will begin on Slide 6. The investment portfolio on line 1 increased by $222 million as deposits acquired in our CFS merger exceeded net loans by $359 million creating excess liquidity to invest.

Portfolio loans on line 3 increased year-over-year by $730 million and now totaled $3.633 billion. Pre-merger balances increased by $133 million or 4.6%, and CFS loans totaled $597 million.

The allowance on line 4 totaled $68 million or 1.87% of loans, however, John will detail the fair value adjustments and the allowance coverage of pre-merger loans later in the presentation. Goodwill and CD&I increased by $53 million during the year reflecting the difference between our $136 million purchase price and the net asset acquired. CD&I totaled $7.3 million and will amortize over ten years. Banker owned life insurance increased by $40 million during the year due to the acquisition and improvements in the cash surrender value policy during the year.

The nearly $100 million increase in other items includes approximately $22 million of fixed assets, $26 million of our deferred tax asset, $17 million in interest bearing time deposits and $9 million of other real estate. All of the increases are related to CFS merger.

The composition of our $3.6 billion loan portfolio on Slide 7 continues to be a reflective of a commercial bank and it continues to produce strong loan yields. The portfolio yield for the fourth quarter totaled 4.55% compared to 4.52% in the third quarter of 2013. Fair value accretion totaled just $638,000 including $164,000 from CFS for 45 days.

On Slide 8, our $1.1 billion bond portfolio continues to perform well producing higher than average yields with a moderately longer duration than peer. Our 3.82% yield compares favorably to peer averages of approximately 2.58% and our duration remains just 10 months longer totaling 4.3 years.

Prior to closing the CFS merger, the CFS management team sold nearly 100% of its securities which averaged approximately 1.5 years in duration and yields that the range between 1% and 2%. Post merger, we worked for 45 days to reinvest the cash at yields of 3.6% with a duration of just over five years. The decision allowed for clean clothes and go forward securities that were consistent with our portfolio and investment style.

Now in Slide 9, non-maturity deposits on line one are up $797 million and represents 78% of total deposits. During the quarter, we also refinanced our $50 million subordinated debentures that had a February, 2015 maturity date. The refinance was achieved by issuing $65 million of new subordinated debentures with a 15-year term and are not callable for the first 10 years and that the fixed obligation for those 10 years was at 6.75% interest rate. The $15 million balance differential was highlighted on line 6.

Additionally, during the year we paid back the full amount of our SBLF lending fund obligation totaling $91 million as reflected on line 7 and $34 million of that was during the fourth quarter. The SBLF dividend was going to increase from 5% in 2013 to 7% in 2014 and was not tax deductible. So the entire transaction is accretive to 2014 net income and, more importantly, allowed First Merchants to close the year with an optimal capital structure post integration.

Slide 10, tangible book value per share was the focus of my quote in the press release and deserves some discussion. As of September 30, 2013, our tangible book value per share was $11.56. During the quarter, net income and other comprehensive income improved tangible book value per share by $0.74. It was a combination of earnings and primarily the improvement of the assets that are part of our pension plan that is currently frozen, but the assets performed well creating an increase in OCI.

We paid a dividend of $0.05 which would have resulted in tangible book value per share of $12.25 without our acquisition. As a result, the dilutive effect of the acquisition was $0.08 per share or approximately the first five quarters of earnings accretion meaningfully shorter than the three years that was announced in May.

As I previously mentioned, the mix of our deposits on Slide 10 continues to improve and is comprised 48% demand deposits and 30% savings deposits, our least expensive categories. Total interest expense on those deposits is now just 31 basis points down from 35 basis points as of last quarter.

Slide 11 is a new slide for us and it highlights the results of our capital actions over time. 2013 strong earnings combined with our debt refinance and the merger of CFS produced year-end capital ratios that are above our target levels.

The Corporation's net interest income on Slide 12 increased as expected due primarily to 45 days of CFS performance. The increase in our cost of supporting liabilities during the quarter is due to the debt refinance. The new debt has a higher balance and is more expensive than the old instrument and is now reported as interest expense above the line whereas the savings from paying off the SBLF is reported below the line.

Total non-interest income, on Slide 13, when normalized for line 7 and 8, improved by $1.5 million during the year and does include the impact of CFS for 45 days.

Non-interest expense on Slide 14 totaled about $143.2 million for the year, up from the prior year total of $137.1 million. Included in our 2013 results are $5.4 million of acquisition expenses, as Mike mentioned previously, including $2.5 million of severance expense, retention packages and FICA tax and more than $1.5 million contract terminations and data conversion expense. The remaining amount is made up of professional expenses like banker fees or lawyer fees and our accounting fees.

EPS on Slide 15 totaled $1.41. Higher in net interest income on line 1, reductions in our provision expense on line 2, and lower SBLF dividends on line 9 allowed us to overcome last year's FDIC gain on line 4 and this year's acquisition expense. So the combination of better net interest income, lower provision, lesser SBLF dividend more than well allowed us to make up for the difference of those FDIC gains from a year ago and also allowed us to carry the acquisition expense for the year.

Now on Slide 16 you will notice our adjusted annual EPS over the last three years has increased from $0.80 in 2011 to $1.09 in 2012 and now totals $1.36 on an adjusted basis where the reported numbers are $1.41 for 2013.

John Martin will now discuss our loan portfolio composition and related asset quality trends.

John Martin

All right, thanks, Mark. And good afternoon, everyone. I'll be covering the loan portfolio trends in Slide 18, then discuss year-end asset quality before closing with a look at the allowance and fair value coverage that Mark mentioned earlier, before turning the call back over to Mike for his comments.

So turning to Slide 18, Slide 18 highlights the impact of the recently acquired CFS portfolio and the combination of balances. We experienced balanced growth in the portfolio resulting from both the inclusion of the CFS portfolio as well as organic growth. On line 1, commercial & industrial loans increased $139 million which includes $57 million of First Merchants growth from 2012 to 2013. Construction lending on line 2 increased $79 million for the year which included $64 million of First Merchants growth and, on line 3, non-owner occupied CRE increased $257 million which included $53.5 million of First Merchants growth.

This resulted in an increase of First Merchants originated loan portfolio of $133.5 million or 4.6% and on a combined basis the total portfolio increased $730.2 million or roughly 25%. Before I speak further to the changes in the First Merchants originated portfolio on Slide 19, like to mention the composition of the overall combined CFS and First Merchants portfolio.

The combinations of the portfolios while increasing total loans by the 25% I just mentioned on line 11 neither increased nor decreased any one segment of the portfolio by more than 3% on a proportional, as a proportion of total loans with most categories having a percentage change of less than 1%. The similarity in the acquired portfolio should allow us to apply our existing asset quality strategies and tactics as we work through the portfolio.

So turning now to Slide 19, during the discussion from the prior slide forward, I would just highlight lines 1 through 3 where starting on line 1 in the linked quarter commercial industrial loans increased $109.4 million, which includes $27 million of First Merchants growth. On line 2, construction lending balances were up $27.2 million for First Merchants balance has contributed $12.5 million and then on line 3, non-owner occupied commercial real estate was up $262.1 million with First Merchants contributing $58.5 million to the increase.

We continue to build a dynamic construction lending portfolio and saw seasonally sizable increases in the growth in the portfolio as we continue to see strong demand for multifamily and student housing. As mentioned in previous calls, construction lending on line 2 and non-owner occupied real estate on line 3 are being driven by project funding during the construction phase with the balances moving to either the permanent market or into the bank's loan portfolio at completion. We expect to see the CRE portfolio continue to ebb and flow while trending positively as project funds stabilized and move forward both to the permanent market and into the portfolio.

Now, turning to Slide 20, the trend for the asset quality for the year was favorable focusing on the FMB 2013 column, which excludes the CFS portfolio on lines 1, 2 and 3 non-accrual loans OREO and renegotiated loans respectively were all down 30.1% and 76.4% respectively for the year.

On line 5, NPAs to loans and ORE had a percent decline of better than 1% for the year and continue a favorable trend as the economy improved and we were able to move troubled assets. Moving to the column labeled CFS, the addition of $22.7 million of non-accrual loans on line one, $12.9 million in ORE on line 2 and $95.4 million of criticized assets on line 7 is optically similar to where we started 2013 and on a percentage of loans is better than where we started the year.

So then moving on to slide 21, in the column labeled FMB 2013, which combines the quarterly changes for the last year. This slide shows where the improvement of asset quality occurred. On line 2, the First Merchants originated portfolio in that same column generated $23 million in new non-accruals while moving out -- while we were able to move out roughly $43 million to pay off and refinance restructure ORE and charge off. This resulted in a net decline on line 6 of $19.7 million.

Skipping down to lines 13, the NPA change was $34 million which for the year resulted in a roughly 42% decline in NPAs and 90 plus day delinquent loans. As just mentioned on the last slide, including the CFS portfolio, asset quality is essentially where FMB started 2013, which can best be seen starting on line 13 to the bottom of the far right column for 2013 at $83 million as compared to the top of the column on line 1 where we started the year at $81.4 million.

So now turning to Slide 22, the fair value accounting for the addition of the CFS portfolio impacted the allowance coverage to non-accrual loans, which is highlighted on the graph on the top of Slide 22. It is easily seen the effect of the fair value accounting pushed the allowance coverage to the non-accrual loans down to 120% in what is a new basis for this measure. Even so the coverage remains in line with a year ago levels and is well in excess of 100% of total non-accrual loans. And then on the bottom of Slide 22, the recovery of payments on prior charged off B notes and payments of other smaller charged up notes resulted in a net recovery of $630,000 for the quarter. For the year, net charge gross for $8.1 million of 27 basis points of average loans.

And then finally turning to Slide 23, this is the new slide for the quarter highlighting the allowance coverage and the effect of fair value counting on the allowance. On a combined fair value and allowance basis portfolio coverage is 3.19% on line 7 in the bottom far right column. This coverage includes on line 2, $9.8 million of fair value adjustments to the Shelby County Bank portfolio and $39.6 million on the CFS purchase portfolio. And it helps really provide a comparative basis to our historical allowance coverage.

So then I guess I just close by saying that, before I turn the call back over to Mike, that the portfolio continues to trend favorably in asset quality, our construction pipeline remains strong and our original credit outlook for CFS is in line and somewhat better than our original analysis which positions us well entering 2014. Thanks, and I will turn the call back over to Mike Rechin now.

Michael Rechin

Thanks, John, Martin. On Page 25, I will offer some thoughts on the bullet points there before we take questions. And just start my forward look on 2014 by stating we're going to stick to our plan. We got a multi-year plan that’s really well communicated inside our company for roles and responsibilities; it’s a difficult operating environment, but the plan as served us well, so we are going to stick with it.

A signature event is 30 days out. We are spending significant effort at this point in thorough preparation for our integration that's less than 30 days away. Our goal is the second bullet point speaks to is for client retention and implementing growth tactics. Our goal is to peak the interest of the customers, clients, prospects in those new marketplaces thus through the same phases and the same names that those folks have come to trust over time.

We are off to a good start with this. We look for that to continue. We are seeing the experience, the management skills and the leadership from the Citizens team that has joined the First Merchants. We look for that to continue. Gives me great confidence as for the extensive change event that’s directly in front of us.

In that bullet point, you will see in brackets the term Lakeshore region. My guess is that in future calls you will hear less about Citizens Financial by name and more about our Lakeshore region which has been named inside the First Merchants as the signage change scheduled for the end of February we'll be part of that integration effort.

We are on target for the expense savings that we talked about in May, whether its contracts, vendors technology and talent decisions they are all in place. During the second quarter we ought to get to that operating expense run rate that we forecasted in May which you may recall was for 30% reduction, once the changes have taken place in the overall expense rate of the company.

I look for our Chief Banking Officer to continue our organic growth initiatives throughout the entire franchise, continue the momentum that we have. I’m pleased that in the fourth quarter some of our fee levels particularly in the non-banking businesses, insurance and trust were up. Treasury management are up offsetting the slowdown that I think most financial institutions have been in the mortgage business. So if we can get any resurrection in mortgage volumes into the spring coupled with the momentum that the businesses I just mentioned have I think we have a good chance to have our non-interest expense continue to show life.

We're going to emphasize market coverage; we are available to help our clients grow. That significant not jumping out of a line item is our continued assessment of our retail franchise. We're looking at our distribution system in this past year; we did a couple of banking center combinations whereby we build a new banking center to close too. It’s not our favorite activity but we think there is opportunity for that going forward.

We have a couple of growth market banking centers are going to open up here in the first half of the year we're excited about, we will have activity that will be evaluating right behind that that may or may not mean more banking centers but are -- would be geared towards client service and efficiency.

Now we look at this opportunity with Citizens joining us, our Lakeshore region has more than an acquisition. It’s a important growth market to us. It reminds me in some respects of five years ago when we acquired Lincoln Bancorp which was another recently converted thrift that had a stock pile of commercial bank talent that become part of our company and helped us build what is our best growth market today in terms of loan growth results in the Indianapolis. I liken that to what I see up in Citizens and I’m looking for the management that have joined us there to help us execute in a similar fashion.

Lastly, we're going to look to continue to leverage that integration experience, management depth, technology platforms and our culture, if that market allows to do so. We’ll balance those ambitions with discipline and market choice and in pricing. And hopefully whether it's in 2014 or past that have other opportunities to take advantage for the consolidation of the business while our customers stay forefront in our mind.

So John and Mark and I were all available for questions. And at this point, Mike, if you are still with us, you can open up the mike and we will take those.

Question-and-Answer Session

Operator: Yes, sir. We will now begin the question-and-answer session. (Operator Instructions). The first question we have comes from Scott Siefers of Sandler O'Neill & Partners. Please go ahead.

Scott Siefers - Sandler O'Neill & Partners

Let's see, Mark, I guess first question is probably best for you. Can you talk a little bit about how you see the margin trending over the next few quarters? I guess the adjusted margin was down about 10 basis points to 3.83% and then I guess going forward you'll have the full quarter benefit of the purchase accounting adjustments from (inaudible). Maybe just any thoughts you have on level either adjusted or reported going forward and what you think the major puts and takes will be.

Mark Hardwick

Yes, in this quarter, we only had Citizens for 45 days but their core margin was running materially less than outs like what 3.30%. We've made some pretty significant changes in their bond portfolio and increasing those yields from 1.5% to 3.5%, but in the fourth quarter we were still purchasing investments, and I would say we probably because of the time that that sort of left with about $225,000 of earnings on the table as we were transitioning.

The other I think key item we had $164,000 of purchase accounting accretion that came in in the fourth quarter just related to CFS and I'm anticipating that that is $500,000 a quarter type of number absent any activity around the non-accretable yield section. So we have a little right around $14 million that is in accretable, the remainder of our marks are in the non-accretable section and it takes a pay off before that comes back in. So in our -- the FDIC transaction from last year at Shelby County we were surprised how fast that that came back but it was a troubled institution and we're not anticipating that these -- that the marks we have today will come in quite as quickly, and they're also there to absorb losses. So I guess on a go forward basis kind of how I'm viewing it without giving you a specific margin number.

And then was there a second question?

Scott Siefers - Sandler O'Neill & Partners

No, that got the first part of it, so I appreciate that --

Mark Hardwick

Okay.

Scott Siefers - Sandler O'Neill & Partners

And I just wanted to switch gears just a little, I apologize if I missed this in your comments on capital, but can you talk a little bit about intangible book and the capital levels? I guess I would have anticipated they come under little pressure given the closure of the deal but they were both up. So how are you thinking about sort of the pro forma level of the earn-back period you had articulated when you originally announced the merger etc?

Mark Hardwick

The best thing about 3% dilution which would have been about three-year earn back based on the accretion that we've layered in which does accelerate after the acquisition and into the second year, and that's mainly because of somewhat balance sheet growth that we're anticipating in the second year. Year One we weren't anticipating growing the balance sheet just as we're working through some of the problem credits.

The (inaudible) --

Michael Rechin

And so it's effectively, Scott, I think I heard your question as well, its effectively a one-year five quarter kind of a recapture versus the 11 or 12 quarters that our initial modeling contained that we shared a few months back.

Scott Siefers - Sandler O'Neill & Partners

Okay.

Mark Hardwick

Yes, sorry about that, I lost my train of thought for a moment. The 11.56 where we start in the quarter didn't prove -- the question that you were getting to was the OCI was such a dramatic change in the first quarter that it produces a result at the end of close that looks materially different than we anticipated. With the other half of that and its kind of equally split is because our fair value marks weren't as the on the loan portfolio more like $40 million instead of $52 million and the core deposit in tangible was more like $7 million instead of $11 million. And so we had a couple of nice pickups there that helped strengthen the tangible book value per share post closing.

Scott Siefers - Sandler O'Neill & Partners

And then I think just the last question I have is on the tax rate, it buzzed around a bit over the last several quarters, I think its been as high as 28% and as low as 20%. What kind of tax rate should we be using for our models here as we look out over the next year or so?

Mark Hardwick

Well, we've had a couple -- well two quarters in a row with fairly sizable low income housing tax credit type of deals that were finalized and so it created a little bit of, especially last quarter, a sizable loss or negative income in the non-interest income section offset by a big tax adjustment. We had a similar adjustment in the fourth quarter but the effective rate going forward is 27% is more of an effective tax rate that you could expect on a go forward basis. Really 35% applied to everything after you deduct out our tax free income from bank and life insurance and our tax-free munis. That's more of a standard.

Operator

The next question we have comes from John Barber of KBW.

John Barber - KBW

My first question was related to the loan mark. In the press release, you talked about $40 million loan mark and I just wanted to make sure I'm comparing it correctly compared to your initial expectations that there would be a $52 million loan mark, I guess what was the difference there and what improved?

John Martin

Hi John, this is John Martin. When we went into it, we did our due diligence. And one of the things that we do is order appraisals. And as we start to receive those back on both the ORE balances as well as the classified went through an ordered appraisal on virtually every classified assets as well as a number of the accretized assets well to get refreshed and updated appraisals on the values that we had that helped derive the marks on the SOP the non-accretable portion of it, we are better than what we had initially done in the due diligence. We set those marks with a fairly aggressive or conservative stands not knowing what we would see back and as we got it back, we adjusted it.

John Barber - KBW

Okay, thanks for the color. As it relates to the deal, are there any revenue enhancement opportunities that you are seeing that maybe you point that as apparent a couple of months ago?

Michael Rechin

Well, it's early but the opportunities that we saw two quarter ago at the front end of the announcement and today are the same. It was a very traditional spread dominated banking company absent, at least in our case, a trust business or an insurance business. So introductions of those capabilities have begun. I feel like their competency and talking their clients about them will grow over a time, we don't have a lot of that factored in the 2014 as we get the training in place to bring the capabilities to life.

Outside of the those two businesses, John, we have been proficient in using swaps for instance with our commercial clients which is we think a interest rate management technique that their clients would be benefit from, but those the two primary non-banking businesses would be our greatest upside at this point.

John Barber - KBW

All right, thanks, Mike. And the last one I had was just related to deals but this is kind of a two part question, but the first part is you identified capital target ratios. I'm just wondering if there a opportunity came along how your willingness to go below those target levels? And then just a second kind of part of that question, we have seen a couple of deals announced recently it was like pricing for some and not all deals are affirming a little bit, we're talking about one-eight, two times tender book value that level. Does that make that raise sellers expectations or does it make maybe banks look at potentially selling as a more attractive option, they look at that price and say it's pretty good, well maybe think about selling. So any comments to those questions would be great. Thanks.

Michael Rechin

Well, the first half of your thesis on does it raise seller expectation, I think that's clearly the case. We are not involved in all that many active discussions but anyone that would be looking at that potentially would look at the last handful of transactions that took place. And so that's disappointing a little bit because I haven't seen in our opinion a value on the other side of that price that would make you feel great about the prices going up as much.

Mark Hardwick

And well, our currency is up which does help I mean, obviously creates a higher deal value for the same number of shares. And so I think all the deal values are increasing as banks start to raise but the comment about capital those are not part of minimums. I would imagine that if the right deal came along with the proper tangible book value earn back that we would allow those numbers to drop below 8% modestly and then and quickly return back to levels better than the target.

Operator

The next question we have comes from Stephen Geyen of D.A. Davidson

Stephen Geyen - D.A. Davidson

I think I missed this, but I think that was about $5.4 million in acquisition related expenses, $2.5 million in severance, $1.5 million in contract termination, just wondering where the other portion came in on the income statement? What was it?

John Martin

Yeah, it was $2.5 million if you look just what's it for the year, $2.5 million in salary and benefit, we had a couple of hundred thousand in equipment and over $2.5 million in the other category that was made up of whole set of items.

Michael Rechin

Investor banker fees, legal fees.

John Martin

Contract terminations that we mentioned already.

Stephen Geyen - D.A. Davidson

Okay. And for the quarter what was the amount?

John Martin

It was $4.5 million for the quarter and the same $2.5 million in salaries and benefits, the same $196,000 or $200,000 on equipment, and then a little over $1.7 million in other that was the same type of things just slightly lesser amounts that's happened in the fourth quarter.

Stephen Geyen - D.A. Davidson

And as far as the, you had mentioned the 30% reduction that's going to be fully in the second quarter of 2014?

Michael Rechin

It will probably into the third quarter for certain. We have a calendar that kind of lays out when we realized those expense savings, some of them have taken place already. The heaviest one relative to FTE really begins to hit in May timeframe because we keep a full team of folks effectively and place through integration and about a month after integration to make sure that it was done well but, yes, by May on a monthly basis it will be in good shape.

Mark Hardwick

We are yet to recognize about $6.5 million of the savings that will happens post integration.

Steve Geyen - D.A. Davidson & Co.

I got. Okay. Perfect. And -- I’m sorry.

Mark Hardwick

$6.5 million on an annualized basis.

Steve Geyen - D.A. Davidson & Co.

And you talked a bit about the construction pipeline typically those loans are going to stay on the books or maybe a year and then it’s a matter of -- it's a question of where they go? Do they go to the preliminary market or stay on the balance sheet, what do you think the likelihood as being able to retain some of those loans?

Mark Hardwick

I think we got a balance. We underwrite them to the secondary market, and I see the construction pipeline continuing to be stable and maybe trending upwards. But in terms of retaining it in the portfolio really dependent on the -- what the investors objectives are. I would say a percentage of them will stay on the balance sheet but I wouldn’t expect to have a huge jump.

Michael Rechin

The terms of the permanent market are, this is Mike, again Steve. The terms of the permanent market attractive to our clients. And so we feel like once those projects stabilize which is in my mind more like two years rather than one, they ought to qualify for non-recourse permanent financing at rates that we typically wouldn’t want long-term on our balance sheet. It also gives us more capacity to work with those same clients on additional projects or other clients. So that flow we are kind of pleased with.

Steve Geyen - D.A. Davidson & Co.

Okay. Very good. And last question on commercial and industrial, just curious if you have kind of a broad view from your customers as far as what their outlook is for 2014?

Michael Rechin

I think guarded. We view, I mean I welcome the chance to compete not only in our existing franchise but up north. I think our clients are guarded, I think they all had fairly successful 2013 and much like this time last year, they are trying to digest the change in front of them. I’m pleased I saw Indiana unemployment numbers came down again either yesterday or today let’s got to help people out. I think healthcare needs to be understood on a broad basis but I would hope that this spring is going to be optimistic and replenish our pipelines. Our pipeline is a little bit lower than it was at the beginning of the fourth quarter, but not by a whole heck of a lot. We had a very strong quarter. So sometimes we pick up loan volume on a usage basis that never actually is in your pipeline just on greater utilization.

Operator

Next we have Brian Martin of FIG Partners. Please go ahead.

Brian Martin - FIG Partners

Hey Mike, just kind of follow on the last question. What your expectation be with kind of better momentum in the commercial side, but maybe the overall long growth organically in 2014 a little bit stronger than it was in '13 just economically things getting better?

Michael Rechin

Well, economically, yes. I would like to think that the fourth quarter would be a favorable look forward. A couple of things ought to offset that. One is that was a 14% plus or minus annualized run rate I don’t expect that in 2014. We have a couple of drags. One of them would be we do have with a $600 million of servicing loans, some asset quality remediation that I think will take place by virtue of a client finding another place to do business. And so I think that will offset a little bit.

Having said that, all the horsepower in that Lakeshore region is geared towards getting out and telling the First Merchants story. On a legacy First Merchants, our core business, I think I'm going to give you the same look that I did this time last year, which is at a mid to high single digit number is what I believe we can achieve based on what we see in the market.

Brian Martin - FIG Partners

And then maybe just two housekeeping questions. Were there any outsized OREO gains in the quarter just kind of looking at that fee income number too a little bit stronger than I thought, but was there anything in there that was unusual this quarter and the people commenting maybe Mark just, maybe I didn't catch what you said about the just kind of accretion that rolls through, I guess it was $600,000 or so this quarter, if you gave some color, I look that it is prospectively higher thinking about it would be perfect?

Michael Rechin

Yeah, I think, Brian, as for as the OREO number is concerned we did have recovery in the quarter. As you saw the OREO portfolio go down from $12 million to $9 million in the FMB core, it was $2 million or so that we took back in the income.

John Martin

And the fair value accretion it was $154,000 for CFS just for 45 days, and I would anticipate around $500,000 a quarter absent any pay downs on the non-accretable portion of the portfolio. So, now that assumes of our five-year amortization of the accretable yield and --

Brian Martin - FIG Partners

Is that -- just upon that maybe this one asking for John, the organic loan growth you guys achieved in '13 from the Indi markets there was how much of the 133, I think in organic was tied to Indi and where the Indi balances stand today?

Michael Rechin

Well, our balance through the Indianapolis region at year end is $1.1 billion.

Brian Martin - FIG Partners

Okay.

Michael Rechin

As it relates to the organic growth in the fourth quarter, I don't have a specific number. Actually I do. I can speak to the closing in the central region which is what our moniker is for Indianapolis, but that doesn't really relate to the net balances.

Operator

The next question we have comes from Daniel Cardenas of Raymond James.

Daniel Cardenas - Raymond James

Just maybe going back to M&A, maybe we could speak a little bit as to what the chatter is as they're picking up in the state just given the kinds of how fresh you are off of this deal. I mean, how soon do you think you could go back into the market and do a deal if the was the right deal?

Michael Rechin

Well, pretty quickly. I feel like you know the barbell of work that goes into this integration would be on one hand and that hasn't taken place yet, but the upfront work on getting to know management teams, doing preliminary due diligence, reaching some kind of a general agreement on value, and then understanding that the approval process is six months long, I would tell you that if we had back up from that we would be able to move in the current time period if you have found something suitable.

Daniel Cardenas - Raymond James

And then in terms of expectations I may have missed it, you may have said this before, but are seller expectations stabilizing here, are they still -- are they beginning to pick up in terms of what they like --

Michael Rechin

No, you would have as good a perspective as I do, but I think they have to be moving up between, there was a Fort Wayne transaction announced that was rich, fully priced I would say. Everything I've seen would suggest that the kind of price or value we are able to find for our billion-dollar bank in Citizens would be hard to come by again coupled with town in that bank and the quality of the marketplace.

Daniel Cardenas - Raymond James

And then if you think about potential expansion, I mean is that would it be primarily in the Indiana marketplace or would you be willing to maybe build up your presence in Illinois and Ohio or perhaps enter it to another market all together?

Michael Rechin

I would answer consistent with that question in time past, which is any of the states contiguous to Indiana, Kentucky, Ohio, Illinois would all have interest to it, perhaps even Michigan although we haven't spent a lot of time looking in that but the other three in addition to which rounding up is still significant amount of market attractiveness in my opinion in Indiana, but clearly downstate Illinois, Central Ohio, Southern Ohio would be very attractive.

Operator

At this time, we have no further questions. We will go ahead and conclude our question-and-answer session. I will now turn the conference back over to management for the closing remarks. Gentlemen?

Michael Rechin

It's Mike. Michael, I appreciate you hosting the call. I'm thankful for the long term interest in our performance and look forward to talking to you again on a couple of months when we have a little bit more clarity as to how all of our integration efforts come together in first part of 2014. Thank you all.

Operator

And we thank you, sir, for the rest of the management team for your time today. The conference call is now concluded. We thank you all for attending today's presentation. And this time you may disconnect your lines. Thank you and take care.

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