Mercantile Bank Corp (MBWM) 2004 Q1 法說會逐字稿

Welcome to the Mercantile Bank Corporation first quarter earnings conference call. There will be a question-and-answer period at the end of the presentation. If you have a question at that time, please press star then the number 1 on your touch-tone telephone.

Before we begin today's call, I would like to remind everyone that this call may involve certain forward-looking statements such as projections of revenues, earnings, and capital structure, as well as statements on the plans and objectives of the company or its management. Statements on economic performance and statements regarding the underlying assumptions of the company's business.

The company's actual results could differ materially from any forward-looking statements made today due to several important factors. Described in the company's latest Securities and Exchange Commission filings. The company assumes no obligation to update any forward-looking statements made during this call.

If anyone does not already have a copy of the press release issued by mercantile today, you can access it on the company's website. www.mercbank.com.

On the conference today from Mercantile Bank Corporation we have Jerry Johnson, Chairman and Chief Executive Officer, Chuck Christmas, Chief Financial Officer, and Bob Kaminski, Executive Vice President. We will begin with management's prepared remarks and then open the call up to questions.

At this point I would like to turn the call over to Mr. Johnson.

Thank you very much, and thanks to all of you for joining us this morning. We very much appreciate your interest in Mercantile Bank Corporation.

Mike Price and his family are on a well deserved vacation. He does send his regards to everyone and I believe he is listening in. So with that, we'll move on to an analysis of the exceptional results that we believe we achieved in the first quarter.

The first quarter of 2004 was, as I said, an exceptional one for us, especially in light of the fact that first quarters have almost always been our most difficult in terms of asset and earnings growth as current customers begin assessing and implementing plans for the ensuing year and new expenses come on line for the bank. However, because of our continued strong market share growth and our commitment to cost containment without sacrificing service, first quarter sequential loan growth of $75 million was 29% and most importantly net income increased 33% over the year-earlier period.

I believe that this is one of our strongest income and loan growth first quarters ever, and probably one of our strongest quarters of any time. This is especially significant when you consider that many financial institutions, especially those who concentrate on commercial lending, are disclosing that significant loan growth was difficult if not impossible to achieve in the first quarter. I think our market share growth really is in direct contrast to that.

I would also add that our loan growth was achieved while maintaining excellent asset quality. Although strong loan growth always has a slightly deleterious impact, our quarterly operating performance was excellent as I mentioned and you can see, and the first quarter growth does set our company up for continued strong operating performance throughout the balance of the year.

This morning we were pleased and are pleased to announce not only earnings but the continuation of our 9-cent per share quarterly cash dividend as well as our fourth consecutive annual 5% stock dividend. There are a number of exciting things happening at mercantile and li turn the call over to Chuck and Bob to further discuss our earnings and corporate development. Chuck.

Thank you, Jerry, and good morning to everyone.

As typical what I would like to do is give you an overview of Mercantile's financial condition and operating results for the first quarter of 2004 highlighting the major financial condition and performance balances and ratios. As has been typical the underlying them of Mercantile's financial numbers reflect the continued successful implementation of our strategy that being our concentration on business lending, strong asset growth, led by growth of the commercial portfolio, high asset quality, improved fee income performance, and controlled overhead costs. Notwithstanding that our financial results continue to reflect significant provision expense due to the very strong loan growth that we have experienced as well as the relatively frequent CAPA raises that we've accomplished to date.

With regards to earnings performance as Jerry already touch on net income for the first quarter of this year was $2,973,000, that is a $740,000 or 33% increase over the $2,233,000 that we made in the first quarter last year. An on a diluted earnings per share basis for the first quarter this year it's 43 cents. That's an increase of 7.5% over the 40 cents we made in the first quarter last year. Obviously the big impact there is that our average shares are up 25% due to the stock offering that we completed in the fall of 2003.

With regard to net interest income our overall profitability continues to be driven by strong earnings asset growth which is translated into increased net interest income further supported by a slightly increased net interest margin quarter over quarter.

In the first quarter this year our net interest income totaled $9.5 million. That's an increase of $2.7 million or 40% over the $6.8 million we recorded in the first quarter last year. Earning assets at the end of the first quarter of this year totaled $1.23 billion, up $320 million, or 35% from where we were 12 months ago.

Loans grew during that time period of $299 million or about 3% of the total increase in earning assets. That interest margin for the first quarter this year was 3.26%, that is an increase of 9 basis points over the 3.17% in the first quarter 2003 and equals what the net interest margin was in the fourth quarter of last year.

Overall we continued to maintain a steady margin as exemplified during the past five quarters our net interest margin has been in a range of just nine basis points. The range as well as the slight increase is primarily due to the positive impact of CD repricing, and the positive impact of our stock sale which is slightly more than offset our decline in asset yields.

As far as looking forward again we don't provide specific guidance with regard to earnings as well as our net interest margin but assists in the past our main issues with regards to the margin continue to be loan yields, any action or inaction by the federal reserve and the overall funding structure of the wholesale fund. With regards to our new loans, our borrowers continue to elect variable rate over fixed rate in most cases. Again that equates the about a 4% floating rate versus a five-year fixed rate of 6 to 7%.

Variable rate loans at the end of the first quarter totaled $839 million or 75% of our portfolio. Again about 40% of that $839 million are at floors and will take anywhere from 25 to 50 basis points of increase in prime rate until they become fully indexed. At the end of this year beginning of last year, about 74% of our loan portfolio was tied to prime. Three years only about 35% of our portfolio was tied to prime, so the increase in the level of floating rates continues, albeit at a slower pace.

With regard to our wholesale funds our cost of wholesale funds have declined as rates have fallen. At the end of the further quarter our wholesale funding portfolio again comprised of brokered CD's, and federal home of bank advances had an average rate of 2.27%, it was down eight basis points from where we ended last year. During the last year and one quarter it's down over 100 basis points, and since the end of 2001 we're down 233 basis points.

Given the current rate environment we still have some repricing opportunities although certainly not to the degree that we've seen over the last couple of years. For the remainder of 2004 we have about $425 million set to mature at an overall cost of 2.05%. To put that in perspective the current 12-month brokered CD rate is about 1.75%, the 18-month rate is about 2.15%.

Moving on to loan loss provision in the first quarter we expensed $1.2 million almost doubling the $600,000 we expensed in the first quarter last year. The increase is primarily due to higher loan growth where we grew loans $75 million in the first quarter this year compared to $40 million in the first quarter last year and to a lesser degree a slightly higher level of net charge-offs about $286,000 compared to $109,000 in the first quarter last year. Again the majority of the provision expense continues to be due to loan growth and not excessive net loan charge-offers.

Moving on to fee income, excluding securities gains, fee income in the first quarter of this year was $961,000, a slight decrease of $26,000 or 2% from what we earned in the first quarter last year. With regards to the significant changes our service charges on the positive account continue to show very good growth totaling $299,000 in the first quarter an increase of $30,000 or 11% from the first quarter of last year. Our letter of credit fees in commercial deals also saw a significant increase totaling $101,000 this year versus $35,000 the first quarter last year or an increase of $66,000, that primarily relates to a timing difference with FASB changing the rules on recognizing interest income on letter of credit fees and therefore resulting in some timing differences.

Mortgage fees as I'm sure with most banks if not all banks we had a decline in the first quarter of this year. Again with significantly lower level of refinancings with slightly higher interest rate environment.

Mortgage fees totaled $136,000 this the quarter compared to $281,000 in the first quarter last year. That's decrease of about $145,000. With regards to our other product and services, during the first quarter of this year we generally saw higher levels of income in each of our categories, fee income, primarily resulting from an increased number of accounts.

Moving on to overhead cost in the first quarter of this year we expensed $5.2 million, that's a $1.2 million or 30% increase over the $4 million we expensed in the first quarter last year. What's important to note that while the $1.2 million is relatively significant, relatively pales in comparison to the $2.8 million increase in net revenue. Again, we're growing revenues much fast than increase in our cost structure.

Our efficiency ratio in the first quarter of this year was 49%, an improvement from the 52% that we had in the first quarter of last year. With regards to growth in overhead costs of the $1.2 million increase quarter over quarter about $800,000 or 67% is related to salaries and benefits. FTEs increased from 128 a year ago to 167 people at the end of the first quarter this year, a 30% increase, with a majority of that increase taking place in the second and third quarters of last year. Our occupancy and equipment expenses were also up primarily due to the opening of a branch facility and our Holland office in May of 2003.

Our general and administrative costs are also up primarily due to increased asset base. Once again there were no one-time expenses or charges.

Moving on to the balance sheet for a couple minutes, and first of all starting with asset growth, at the end of the first quarter, our assets totaled $1.29 billion, that's an increase of $91 million, or an annualized rate of 30% during the quarter. Of that $91 million increase in assets, $75 million was an increase in loans. Again, equating to about a 29% annual growth rate.

During the last 12 months or assets have grown about $326 million or 34% with loans growing $299 million or a 37% growth rate. Our asset structure continues to remain consistent with no major changes in the composition, maintaining loans at about 84 to 85% of assets and other investments at about 10%.

With regards to our funding, our funding strategy has not changed significantly as we continue to grow our local deposits as best we can and bridge the funding gap with wholesale funds, again that being brokered CD, bank advances. The first quarter 2004 saw very strong local deposit growth with local deposits up $41 million from the beginning of the year annualized growth rate of 53%.

Demand accounts were up $9 million during the quarter, or 49% annualized growth rate, savings deposits were up $18 million, or a 73% annualized growth rate, and local CDs were up about $11 million, a 48% annualized growth rate. Our wholesale funds were up $61 million for the quarter, equating to about a 36% annualized growth rate.

Overall our whole sale funds to total funds at the end of the first quarter stood at 64% compared to 65% at the end of the last year. Again, a relatively -- the level of wholesale funds to total funds remains stable despite our significant asset growth.

Lastly, a couple comments with regard to capital. We continue to remain in a well capitalized position for bank regulatory definition, risk-based capital ratio at the end of the first quarter at 13.2%. That's my prepared remarks.

I'd certainly be happy to any questions in the Q and A session. But now I'll turn it over to Bob for his remarks.

Thank you, Chuck.

As Chuck and Jerry outlined in their comments, Mercantile had a very strong growth quarter in terms of loans to start 2004 led by growth in the commercial loan area, total loans were up $75 million in the first quarter. While growth has come primary from new business opportunities, there were some good activity in new project from existing customers. Mercantile continues to entertain new business opportunities from prospects other new lenders added to staff in mid 2003. Pipeline remains in good shape as we head into mid 2004 and should allow the bank to continue while probably not at the pace of the first quarter with a solid growth rate for the rest of the year overall.

We are pleased with our asset quality numbers. Charge-offs, past due and non-performing loans are all well below that of our peer group. While the non-performing total is up from the prior quarter, we have continually stressed at each conference call near zero past dues cannot be expected to maintain indefinitely especially in the present economy.

As a commercially focused bank, there will be work out credits which occasional come and go causing peaks and valleys in that measurement. The nonperforming total primarily represents two real-estate contracts which are currently in work outstatus the real estate nature dictates a longer workout period on the deposit front Mercantile had some excellent new local deposit relationships commit to coming on board during the first quarter, and these have already begun to start funding in the second quarter and will be continuing so through the rest of this quarter.

Mercantile is experiencing good activity in the New Holland office. What was initially opened as a loan production office now has become a full-service branch in the first quarter, and is able to offer all banking service at this location. Mercantile has been able to get good commercial loan penetration in the lakeshore area and is continuing to entertain some good potential customer prospect going forward.

Work continues on the construction of Mercantile's new downtown office in Grand Rapids and the New Holland banking center Holland should open in the fourth quarter 2004 and the new Grand Rapids office should open in the second quarter 2,005.

That is the extent of my prepared remarks. I'll turn it back over to Jerry.

Thanks, Bob and Chuck. At this point we'd be happy to take your questions.

I'd like to remind everyone in order to ask a question please press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q and A roster.

Your first question comes from Terry Mcevoy of Oppenheimer.

Looking at the $75 million of loan growth this past quarter, can you break out in any way the growth generate by the newer commercial lenders who are transitioning their books over to mercantile versus growth coming from lenders who have, say, been with the company from the earlier days?

I would answer that, Terry. I would say it's probably about half of the -- it's a rough guesstimate, about half of the growth has come from some of the newer added lenders and the rest of it came from some of the lenders that have been with us for longer period of time.

Another question, if I could. The way I've always looked at your quarterly loan loss profession has been the provision relative to new loan growth that quarter in the first quarter the ratio is around 1.66%, in the fourth quarter 1.48%, in the third quarter I think it was 1.3%.

How much of the provision this past quarter was relate to loan growth and how much would you say was connected to the, what, about a million dollar increase in MPA.s and slight increase in charge-offs, and as I model future quarters should I be looking at Q1 as a better run rate to use in terms of relationship between overall loan growth and the provision?

This is Chuck, I think with regard to the permission you quoted I think what you're seeing a little bit there is some of the peaks and valleys with our net charge-offs in the quarter as well as slight change in our coverage ratio which as you can see went from 139 at year end down slight to 138 at the end of the first quarter. So I think that's where some of the number gyrations are coming from.

We continue to use the same methodology that we've used since inception of the company which is, you know, a calculation based primarily on loan rating. And as those ratings obviously change from time to time, you know, the overall need of our reserve is going to change from time to time, but obviously if you look historically the reserve level from a coverage standpoint has stayed relatively consistent, primarily reflecting change in loan rating within the portfolio. So it's kind of hard to give you a number going forward, you know, as far as what the coverage ratio is going to be because it really is dictated by the overall financial health of our loan portfolio but I think if you, you know, I look at, and if you look at it from a historical perspective I think it's been relatively consistent and I don't think we see any significant changes coming down the line.

Thanks, Chuck.

Your next question comes from Steve Covington of Stifel Nicolaus and Company.

Who?

Good morning, guys. Great quarter.

Thanks, Steve.

Just a couple quick ones. Was the growth balance throughout the quarter? Did you have any months that were significantly more than others?

I knew you were going to ask that question, I should have just put in that my prepared remarks. From a month to month standpoint it was relatively consistent. January was $22 million, February was $24. And March was $29. I think the thing I would like to add as far as with March is almost all that growth happened in the last two weeks. I don't know why, but we did have a lot of loan growth in the first couple of weeks but we certainly did a lot in the last couple of weeks. So if you look at it on a monthly base it's relatively equal but I'll just put that one caveat in there about March.

That's great. Secondly, Bob, can you give us a little bit more color on the two commercial real-estate relationships that you have in non-performing? Just basically your security position or loss expectations or loss potential.

I would say as I mentioned there are two commercial real-estate credits, the loss that we estimated in those two particular credits was taken in the first quarter, and what remains in terms of non-performing loans we're not estimating any potential estimated loss at this time on those two credits.

Okay. And it sounds like those could be there for, you know, six to nine months as you kind of work through those positions.

Possibly. In the worst case scenario, real-estate workouts just take a little longer and that could be a possibility.

Okay. And then lastly, if Jerry, or Bob, if you could give us a little bit more color on the overall economy and in addition some color on the competitive landscape, any major changes from any of your competitors and things like that.

Oh, I think as Bob mentioned in his remarks, we did experience some good loan growth from our existing customers. Here to for, for the last 18 months, really the bulk of it has been market share driven, but we are seeing our current book of business starting to do some more things. We're certainly not seeing deterioration in asset quality, and we do see some of our customers actually picking up in sales, margins improving, et cetera.

Bob, I don't know if you have any other comments.

Jerry makes those good points. It is very competitive, as this market has typically been. You see some crazy things out there and you pick and choose your battles, and some deals you have to walk away from because they're absolutely crazy. So I think echoing Jerry's comments about the economy, there are still sectors that are struggling but we're starting to see a little sign of maybe something starting to turn around and that is reflect in increasing activity from existing customers.

Thanks, guys.

Thanks, Steve.

Your next question comes from Barry Mandel of Mandel Money Management.

Question on the FTEs. What kind of growth do you see in the FTE say now through year end?

Barry, this is Chuck.

Certainly we're not going to see the pickup that we saw last year, although we do certainly have budgeted from hiring. I'm not sure of an exact number. We're at 167 now. I don't know if 175ish is probably where we'll be at the end of the year, maybe 180.

Obviously we go through and budget for staff addition but as you've seen since Mercantile's existence when we have great individual out in the marketplace that we have the ability to hire on to our team we certainly go ahead and do that, and there's actually an example here in the first quarter of that. Again, we're not budgeting a huge increase. Maybe eight to ten more people is just a guess at this point in time, but again that could change if some opportunity come our way.

We don't have -- this is Jerry Johnson.

We don't have any more branch openings per se budgeted, and we really did a lot of work in bolstering up our back-room operation last year. So we really should be able to leverage quite a bit off of the hiring that we did throughout 2003.

So we should see expense growth to be slower than revenue growth.

Certainly be lower than what it was last year. Put it in that terms.

Okay. Thanks.

Your next question comes from Brad Vanderprogue of Raymond James.

Congratulations on a great quarter. Do you sense, just to elaborate a little more on the state of the economy, are some of your small business clients, are they starting to draw down deposits maybe in advance of turning to credit? Do you get any feeling that that's happening, or are we not even quite there yet?

I'll let anybody that wants can comment, but we're seeing is basically a buildup in deposits more than a drawdown. Chuck, I don't know if you have --.

Yeah, I think we saw, up, a lot of drawdowns last year. As the cash flow tightens up not only the small companies but of the big companies as well. So although their lending needs weren't as significant they were first drawing down on their deposits before they were getting to the interest expense of their P&L.

Does that make you less optimistic then about loan growth if you see deposits building back up, maybe less of a need for credit?

No, Brad and I think one of the reasons is that, you know, our primary customers in general don't keep huge cash balances anyway. We get all of them that they have, but small to medium-sized businesses typically are much heavier borrowers than they are deposit generators. So that impact, at least in my opinion, is not very significant.

Okay. And then in terms of the 10-year treasury rate, it moved around quite a bit in the first quarter and actually got down to a pretty low level. Did that -- were you guys able to capitalize at all on in that terms of the mortgage banking? Did you see a little bit of a pickup there? I'm trying to get a feel for what the second quarter might look at now that the rates have gone back up.

I think you're right there were a lot of peaks and valleys and as people saw the rates go down, they started thinking about refinancing, and by the time they called their banker, I think the rates popped back up. The income we had this first quarter verse last year's first quarter was, you know, significantly down.

Right.

I'm sure that's going to be common throughout the industry. As far as going forward I think it's going to be relatively steady from what you saw in the first quarter.

Again, obviously rates are going to be a big determinants of that, but certainly getting in the 3.7 and 3.8, thou we're looking at 14, maybe even higher as some people are predicting. We continue to after good pipeline. We certainly have a good handle on the marketplace with new construction and as people look to buy new homes so I think generally speaking, obviously interest rates will play a big key here, relatively consistent what you saw in the first quarter going forward.

Okay. And one last thing just in terms of the margin going forward.

If rates were to stay where they are, both on the short and long end of the curve, would you expect throughout the year to be able to generate any benefit? It sound like your incremental funding sources now if you mixed it up between 12 month and 18 month would be about where you are now, so should we -- would that imply a fairly steady margin in that scenario?

Yeah, I think overall one of the things that we help to manage the margin of the bank is the duration of the wholesale funding portfolio, and if we continued on, which I think we will, with the 12 to 18-month average of new pieces coming to the bank, and you look at the rate, I think you're going to probably see, assuming again no interest rate changes, for example, by prime, I think you're going to see our margin go down slightly, just because we're not going to have the repricing opportunities in the wholesale funding market portfolio that we've seen in the past. And again, you know, vast majority of the borrowers come into the bank continue to take the floating rate over the fixed rate.

So I think under that scenario I think you're going to see a slight decline in our margin. Certainly we can change the duration of our CD portfolio and our federal home of banks portfolio to help manage that scenario. But obviously I think we are in agreement that rates are going to go up at some time and we still think it behooves us on a loner term perspective to continue to extend that duration of our wholesale funding program.

This is Jerry again.

I would say that if extending the duration does not have an extreme impact on our margin, and only impact it a few basis points, we think that extending that duration makes a lot of sense. So we monitor it very carefully, but we are pretty committed to extending that duration if we can do it without a major impact on earnings per share.

Okay. And would you be slightly asset sensitive right now, then?

We're very asset sensitive. 75% of our portfolio is tied to prime.

Alan can move anytime. We're ready.

Alright, very good. Thank you.

Thanks, Brad.

Your next question comes from Brad Ness of FBR.

With net charge-off a little bit higher and elevated level of nonperforming assets, are you guys still committed to holding net charge-offs kind of on an annualized basis going forward at that 10 basis points are do you think there's been a little bit of paradigm shift there?

Not at all. We look at our paradigm as being the same as we always have. As we said in the past we demonstrated that there are occasional peaks and valleys and this is example of that.

Okay.

And on the fee-based income side, what's in the hopper as far as really building on that level and having it be a more significant piece of total revenue?

I don't think we -- we're not looking at any new product or service right now, Brad, so I think it's a matter of trying to leverage off of what we have out there now. We've done a pretty good job at leveraging off that. We got in the brokerage business probably at the worst opportunity with regards to the market, but the brokers, for instance, is really starting to pay off for us now with the improved market conditions, and the people we have on staff, so I think it's going to be more of just trying to leverage off the products and service that we have out there now and go from there.

I would say also payroll is another good example, Brad. As we're continuing to add significant customers to that product line, so some of these are new. They were put in place during tough economic times, and again, brokerage and payroll I think are two very good examples of products and services that will play a more meaningful and significant role in our fee income as we go forward.

Okay, and lastly here, as you look at the environment and your projections and operating model, what do you think is the biggest challenge to you guys in 2004?

Bob, do you want to --.

I would say, you know, our big heft challenge that we look at is continuing to keep the rate of growth significant so we can continue to grow the organization and find going people. Those are a couple of the big challenges that are really tied together.

It's always keeping the mission and the focus of the organization in mind. As Bob mentioned it's finding really good people, whether they're frontline or back room, is a real challenge, so that, I think, are two areas of concentration for us for this year.

Okay. Thanks, guys.

Thanks, Brad.

Again, to ask a question, please press star 1 on your telephone. You have a follow-up question from Terry Mcevoy of Oppenheimer.

As large demand remains sluggish while small and middle has been picking up have you noticed your larger competitors having an interest in smaller size loans, and if so has the added competition hurt price?

That's an emphatic yes. They sure have, Terry. They -- we just had a loan board this morning and we're looking at repricing -- I won't call them opportunities.

Yes, the larger banks are definitely aggressively seeking out a lot of the same customers that we bank, and a lot of our current customers that we have taken from them in prior years, and are quoting rates that are challenging at best. We typically have not lost a lot of business just because we're able to sell on service, technology, et cetera, but from time to time, especially when we're quoting on new deals, we'll walk. There's just some absurd rates out there, and just part of the competition, but we've dealt with it before.

Thank you.

But good question.

There are no further questions.

Well, thank you all again for your interest, and if you have questions you think of later, please feel free to call Bob, Chuck, or me. Thanks again.

Thank you for joining the Mercantile Bank Corporation first quarter earnings conference call. You may now disconnect.