First Merchants (FRME) Q1 2026: Non-Interest-Bearing Deposits Jump to 23% as Core Franchise Strengthens
First Merchants’ Q1 2026 results underscore a decisive shift toward core, low-cost funding and disciplined balance sheet optimization, as non-interest-bearing deposits surged and the First Savings acquisition integration advanced. Management’s conviction in mid-to-high single-digit loan growth and margin expansion is anchored in robust commercial pipelines, strategic loan portfolio repositioning, and growing fee income streams. With integration synergies and selective capital deployment in focus, the franchise enters the remainder of 2026 with heightened operating leverage and a clear roadmap for organic growth.
Summary
- Deposit Franchise Remix: Non-interest-bearing deposits climbed sharply, reflecting successful core account redesign and funding cost discipline.
- Integration Momentum: First Savings Bank verticals—SBA, triple net lease, and first lien HELOC—are already contributing to fee income and future growth levers.
- Margin and Loan Growth Tailwinds: Strategic loan sale and asset repricing set the stage for gradual net interest margin improvement and renewed loan expansion.
Performance Analysis
First Merchants delivered a complex but constructive first quarter, with reported earnings weighed by one-time acquisition and loan sale charges, but underlying profitability and core metrics improved. Adjusted EPS rose nearly 10% YoY, driven by net interest margin expansion and fee income growth, even as tangible book value temporarily dipped due to the First Savings acquisition and share buybacks. The bank’s tangible common equity ratio remains solid at 9%, supporting ongoing capital actions.
Loan growth was flat this quarter, owing to outsized paydowns in investment real estate and sponsor finance portfolios, yet management reaffirmed confidence in mid-to-high single-digit loan growth for 2026, citing record production pipelines and robust commercial activity. Non-interest-bearing deposits jumped to 23% of the mix, up from 16% last quarter, reflecting the successful redesign of core checking accounts and a strategic shift away from higher-cost CDs and public funds. Net interest margin improved by six basis points to 3.35%, underpinned by lower funding costs and disciplined loan pricing.
- Fee Income Expansion: Wealth management, mortgage, and loan sales all posted double-digit growth, with First Savings’ specialty verticals poised to further lift non-interest income in coming quarters.
- Expense Management: Core expense growth remains in line with guidance, with cost synergies from the acquisition tracking to plan and integration costs largely front-loaded.
- Credit Quality Stable: Asset quality metrics remain well-controlled, with charge-offs and criticized assets in line with expectations and no systemic deterioration observed.
Overall, the quarter reflects a franchise actively managing through balance sheet transition, while positioning for renewed growth and margin upside as integration and capital deployment progress through 2026.
Executive Commentary
"Our model of community banking in southern Indiana has demonstrated its strength. Turnover of frontline personnel has been minimal, and as the prior pages demonstrated via the growth in loans and core deposits, their clients continue to be patient during the transition."
Mark Hardwick, Chief Executive Officer
"Our quarterly net interest margin of 3.35% increased six basis points from prior quarter despite the lower day count in the quarter which reduced margin by five basis points. Our strong core margin reflected our continued pricing discipline."
Michelle Kaviaski, Chief Financial Officer
Strategic Positioning
1. Core Deposit Franchise Transformation
FRME’s strategic redesign of its consumer checking accounts—Prosper and Proctor Plus—drove a material remix into non-interest-bearing deposits, sharply reducing reliance on higher-cost CDs and public funds. This shift enhances funding stability and margin resilience, a critical advantage in a competitive rate environment. Management expects this mix to remain stable, with non-interest-bearing deposits anchored at 20-23% of total deposits.
2. First Savings Acquisition Synergy Realization
The First Savings Bank integration is on schedule and already delivering tangible benefits, including new specialty lending verticals: SBA, triple net lease, and first lien HELOC. These businesses provide both balance sheet optionality and fee income streams, supporting the bank’s “originate and sell” model and extending product reach across the franchise. Early results show stable production and a natural extension of FRME’s commercial banking focus.
3. Loan Portfolio Optimization and Growth Resumption
The strategic sale of $357 million of low-yielding mortgage loans (3.46% coupon) creates liquidity for higher-yielding commercial lending (6%+ yields), with immediate paydown of higher-cost deposits and a multi-year margin earn-back. Management expects loan growth to accelerate in Q2 and beyond, supported by robust commercial pipelines and new hires in key lending teams.
4. Margin and Capital Management Discipline
Net interest margin improvement was achieved through lower deposit costs and disciplined loan pricing, with further modest expansion anticipated as asset repricing and loan mix shift progress. The tangible book value dilution from the acquisition was less than projected, and capital levels remain strong, enabling continued share repurchases and organic growth investment.
5. Talent and Market Expansion
FRME continues to invest in relationship banking talent, with new hires in commercial, private wealth, and specialty lending. Management is opportunistically expanding in core Midwest markets, particularly Michigan, to augment growth and deepen client relationships.
Key Considerations
This quarter marks a pivotal transition as FRME leverages its expanded platform, remixing funding, optimizing the loan book, and integrating new fee-generating businesses. The strategic context is defined by:
Key Considerations:
- Deposit Cost Management: The migration to non-interest-bearing accounts and reduced dependence on CDs/public funds is structurally lowering funding costs and supporting margin.
- Integration Execution: First Savings’ specialty verticals are already accretive to fee income and offer scalable lending platforms for future growth.
- Capital Flexibility: Strong capital ratios and lower-than-expected tangible book value dilution enable ongoing buybacks and organic expansion.
- Commercial Loan Growth Visibility: Record production pipelines and recent hires point to a rebound in loan balances after Q1 paydown-driven flatness.
- Fee Income Leverage: Originate-and-sell models in mortgage, SBA, and HELOC provide recurring non-interest income, diversifying earnings away from net interest margin dependence.
Risks
Key risks include potential deposit runoff if competitive pressures intensify, integration hurdles with First Savings’ specialty businesses, and credit normalization in CRE and sponsor finance portfolios. While asset quality remains stable, any macroeconomic weakening could pressure loan growth or trigger higher charge-offs. Regulatory changes (Basel III) appear favorable, but final impacts on capital and risk-weighted assets warrant monitoring.
Forward Outlook
For Q2 2026, First Merchants guided to:
- Mid-to-high single-digit annualized loan growth, with commercial pipelines supporting acceleration post Q1
- Net interest margin expansion by several basis points, driven by day count normalization and asset mix shift
For full-year 2026, management reaffirmed:
- Expense growth (legacy) in the 3% to 5% range, with First Savings cost synergies realized in H2
- Non-interest income growth of 3% to 4% sequentially per quarter, reflecting full integration of First Savings verticals
Management highlighted several factors that will drive results:
- Loan growth acceleration as paydown headwinds subside
- Continued remixing of deposits and disciplined pricing to protect margin
Takeaways
FRME’s Q1 2026 results showcase a franchise adeptly navigating balance sheet transition, leveraging deposit remixing and specialty lending verticals to drive future growth and margin. Integration discipline and robust capital position underpin a constructive outlook.
- Funding Base Transformation: The surge in non-interest-bearing deposits is a durable tailwind for margin and franchise value, reflecting effective product innovation and customer engagement.
- Specialty Lending Leverage: First Savings’ verticals are already contributing to fee income and provide scalable platforms for future loan and revenue growth.
- Loan Growth and Margin Upside: With commercial pipelines at record levels and asset repricing underway, investors should monitor the pace of loan growth and net interest margin expansion through 2026.
Conclusion
First Merchants enters the rest of 2026 with a fundamentally stronger funding profile, proven integration execution, and clear visibility on loan and fee income growth levers. Strategic capital deployment and disciplined risk management position the franchise for compounding shareholder value.
Industry Read-Through
FRME’s deposit remix and specialty lending expansion offer clear signals for regional banks: core funding stability and fee income diversification are increasingly critical as rate and credit cycles evolve. The successful integration of acquired specialty verticals—particularly SBA and triple net lease—highlights the value of scalable, originate-and-sell models, which other regionals may seek to replicate. Balance sheet agility and disciplined capital management remain key differentiators, especially as regulatory and competitive pressures intensify across the banking sector.