Mercantile Bank Corp (MBWM) 2004 Q2 法說會逐字稿

Welcome to the Mercantile Bank Corporation second 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 one on your touch-tone telephone.

Before we begin today, I would like to remind everyone that this call may involve certain forward-looking statements such as projections of revenue, 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 at the company's Web site, www.mercbank.com.

On the conference today from Mercantile Bank Corporation we have Gerry Johnson, Chairman and Chief Executive Officer, Mike Price, President and Chief Operating Officer, Chuck Christmas, Chief Financial Officer, and Bob Kaminski, Executive Vice President. We will begin the call with management's prepared remarks and then open up the call for questions. At this point, I would like to turn the call over to Mr. Johnson.

[audio difficulties] has continued unabated in the second with earnings up 24% over the prior year period and sequential loan growth of 27% on an annualized basis. I would add that the significant loan growth, which is certainly not industry-wide, was achieved without compromising our historically excellent asset quality.

Our loan growth was well over our internal projection and as a result had a slightly deleterious impact of approximately 2 to 3 cents per share because of our additions to loan-loss reserve. The good news, however, is that we'll continue to enjoy the earnings on these credits for the remainder of the year in an interest rate environment, rising interest rate environment to be exact, that is favorable to our company.

Year-over-year asset growth was 343 million or 33% above 2003 levels. Of this significant increase, loans accounted for 319 million, representing a 37% increase in loan totals at June 30 of last year.

This morning we are also pleased to announce not only our earnings but also the continuation of our 9 cent per share quarter cash dividend.

There are, as always, a number of exciting things happening at Mercantile, and Chuck, Mike, and Bob will also join me in discussing our earnings and corporate developments further. And with that I'll turn the remarks over to Chuck.

Thank you, Jerry, and good morning to everybody. What I'd like to do this morning is give you an overview of Mercantile's financial condition and operating results for the second quarter of this year as well as the year-to-date basis, highlighting the major financial condition and performance, balances and ratios.

As you will see, the underlying theme of Mercantile's financial numbers reflect a continued, successful implementation of our strategy, that being a concentration on business lending, strong asset growth led by growth of the commercial loan portfolio, high asset quality and controlled overhead costs.

You will also see that our financial results continue to reflect our visits to the capital markets and the significant provision expense necessitated by our strong loan growth.

Under earnings performance our net income for the second quarter of this year was 3.1 million, that's an increase of 600,000 or 24% over the $2.5 million that we earned in the second quarter of last year. And on a year-to-date basis, we reported net income of 6.1 million, that's a 1.3 million or 28% increase over the 4.8 million we made in the first six months of last year.

On a diluted earnings per share basis, we recorded earnings per share of 43 cents in the second quarter of this year. It's a decrease of 2% from the 44 cents we earned in the second quarter of last year, but that is primarily due to the average shares being up about 1.5 million or 26% resulting from the stock sale we did last fall. And on a year-to-date basis our diluted earnings per share are 84 cents, an increase of 2%, again diluted a large degree by the average shares up 26%, again because of the stock sales that we did last year.

The strong increases in net income continued to be achieved due to strong growth in net interest income resulting from earning asset growth, which more than offset the growth in overhead cost, and the significant loan loss provision expense due to continued strong loan growth.

With regard to net interest income, our overall profitability continues to be driven by strong earning asset growth which is translated to increased net interest income, which is further supported by a steady net interest margin.

In the second quarter of this year, net interest income totaled $10 million, an increase of 2.5 million or 33% over net interest income of $7.5 million last year's second quarter. And on a year-to-date basis, our net interest income totals 19.5 million, that's an increase of 5.2 million or 36% over the 14.3 million we earned in the first six months of last year.

Our earning assets at the end of June totaled $1.3 billion, that's up 338 million or 35% from where we were this time last year. Loans are up $319 million or 94% of the increase in total earning assets.

Our net interest margin for the second quarter of this year is 3.24%, unchanged from the second quarter of last year. Overall we have a very steady net interest margin as indicated by the fact that during the last five quarters, our net interest margin has been in the range of less than 10 basis points.

Looking forward, as always, we don't provide specific guidance, but as in the past, the main issues certainly will continue to be loan yields, action or inaction by the Federal Reserve and how the market reacts to those as well as our wholesale funding rates.

With regards to new loans, our borrowers continued to elect variable rates over fixed rates in most cases. Again that results in a 4% loan versus a 6 to 7% if they were to go fixed. That has resulted in a decline in our loan portfolio yield and our overall asset yield over the last couple of years.

At the end of June variable rate loans totaled $925 million or about 78% of our total loan portfolio. At the beginning of the year, variable rate loans equaled 74% of our portfolio and just 3.5 years ago, variable rate loans were only 35% of our loan portfolio, so obviously the floating rate loans have become a bigger and bigger part of our portfolio and obviously a vast majority of those loans today.

Of the $925 million that are tied to prime, about 32% of those loans are at their floors. And the vast majority of those will need a 50 to 75 basis point increase by the Fed before those become fully indexed and start to increase as the Fed potentially increases the Fed Funds Rate even further.

Our cost of wholesale funds have certainly declined as rates have fallen. At the end of the second quarter, our average rate on our wholesale funding portfolios was 2.28%, that's down 7 basis points from where we were at the beginning of this year, and certainly considerably down from where we were over the past 2.5 years.

The recent increases in interest rates will certainly result in increased costs of our wholesale funds. Where before obviously we were having a decline in our costs of our wholesale funds.

For the last six months of this year, our wholesale funds that are maturing totaled about $300 million at an average cost of 1.9%. And in the first six months of next year, our wholesale funds totaled, maturing funds totaled 240 million, with an average cost of 2.1%. To put that in perspective, the current 12-month broker CD rate is currently about 2.5%.

One of the things that we've certainly scene with our wholesale funding costs is that those are tried directly to the treasury and LIBOR market and in contemplation of the Federal Reserve increasing interest rates over the next 12, 18, to 24 months we've certainly seen an escalation in those rates.

With regards to loan loss provision expense, in the second quarter of this year we expensed 1.2 million, that's an increase of 400,000 or 45% over the 800,000 we expensed in the second quarter of last year, and on a year-to-date basis, we've expensed 2.5 million, increase of $1 million or 68% over what we had to expense in the first six months of last year. A majority of the provision expense and the growth is related to our strong loan growth.

With noninterest income and excluding securities gains, in the second quarter we earned $1 million virtually unchanged from the second quarter of last year, and on a year-to-date basis have earned about $2 million, also virtually unchanged from year-to-date 2003. And really what we have seen is, in virtually all nonmortgage-related activities, we've seen really good increases that have offset the decline in mortgage loan-related fees. Obviously with interest rates increasing, the refinance activity has slowed down dramatically.

The major changes within our fee income structure is led by our service charges on deposit accounts which have increased $62,000 year-over-year, and our letter of credit fees which have increased $137,000 year-over-year, which is mostly a result of an accounting change.

Mortgage fees in the first six months of this year totaled $223,000. That's a decrease of $353,000 from what we earned in the first six months of last year, again primarily relating to the increase in interest rates over the first six months of this year.

With regards to overhead costs, we've expensed $5.4 million during the second quarter of this year. That's an increase of 1 million, or 24% from the second quarter of last year.

However, our net revenue is up $2.5 million during that same time period, so we continue to draw revenues much faster than our cost structure is increasing. And on a year-to-date basis we've expensed $10.6 million. That's an increase of 2.2 million, but again at the same time our net revenue is up $5.2 million.

Our year-to-date efficiency ratio this year is 49%, an improvement from the already low 51% in the first six months of last year. Of the $2 .2 million increase year-to-date over year-to-date and overhead costs, 1.5 million or 68% is in salaries and benefits. Most of that due to increased staff.

FTEs at the end of this year are 183 compared to 147 12 months ago, a 24% increase. Other overhead costs are up due to primarily increased asset base. Once again, there are no one-time expenses or charges.

Total assets at the end of the second quarter totaled $1.38 billion. That's an increase of $85 million for the quarter or 26% on an annualized basis. Loans during the second quarter were up $74 million, which on an annualized basis equates to 27%.

Of the $74 million in growth, 40 million of that happen in June. And during the last 12 months, as Gerry already mentioned, our assets are up $343 million, or 33%, of that, loans are up 319 million, or 37%. There are no major changes in our asset composition as has always been the case.

Our funding strategy has certainly not changed significantly as we continue to grow our local deposits and bridge the funding gap with our wholesale funding programs. That primarily being brokered CDs and Federal Home and bank advances.

We are happy to report very strong local deposit growth in the first six months of 2004. Our local deposits are up $62 million, or 20% on an actual basis. That is led by our demand accounts, which are up $37 million, and our savings deposits, which are up $27 million.

Our wholesale funds continue to grow as the bank has with our wholesale funds up about $112 million on a year-to-date basis, or 16% on an actual basis. Our wholesale funds to total funds remains relatively unchanged at 65%, the same level that we were at, at the beginning of the year.

So despite a very strong asset growth, you can see on a percentage basis that our local funds continue to keep pace.

With regards to our capital position, we remain in a well-capitalized position per bank regulatory definitions with our total risk-based capital ratio at the end of the second quarter at 12.7%.

That's my prepared remarks. Be happy to answer any questions in the question-and-answer session but I'll now turn it over to Mike.

Thanks, Chuck, and good morning everyone.

I'm going to keep my remarks this morning fairly brief but again the consistency of the strong growth in Mercantile Bank was evident once again during the second quarter of 2004. As Chuck has already mentioned total assets grew by 85 million, total loans grew by 74 million.

We continue to see most of this growth coming from new relationships to the bank, which is very gratifying. Also very significantly growth of our noninterest bearing deposits has been almost 50% since the end of 2003, a very important benchmark for us.

Asset quality remains strong with both net charge off and nonperforming loans below peer group averages.

And I'd be glad to answer any specific questions you may have at the end of the teleconference but at this time, I'm going to turn it over to Bob Kaminski.

Thanks, Mike.

Mercantile's continuing to experience good activity in all areas of our Holland office, commercial lending, retail lending, as well as branch activity. The Holland office opened as a loan production office in the spring of 2003, is now a full-service branch able to offer all Mercantile products and services to lake shore customers.

Construction work continues on the new Holland main office and is still on track to be completed this October. Work also continues on the construction of Mercantile's new downtown Grand Rapids main office, on Leonard Street at U.S. 131. It is anticipated that this building will be completed in the spring of 2005.

Finally, I wanted to take a moment to mention our payroll product. Mercantile staff has worked very hard to bring new payroll customers into the bank and provide them with that excellent Mercantile service.

I am pleased to report that we now have over 61 payroll customers, 20 of which were added in 2004 alone. And while this revenue for these payroll customers is not a significant number at this point in time, it does provide yet another value-added service to the total banking relationship for Mercantile Bank.

That's my remarks. With that I will turn it back over to Gerry.

Thanks, Bob. And before I, we open up for questions I do want to make one comment on Chuck's remarks.

We tend to focus in these teleconferences on our funding costs and primary loans with floors, but I don't want any of you to lose sight of the fact we have almost $600 million in loans that are repricing upwards every time the Fed raises interest rates and that is significant for us. So this is a very favorable interest rate environment for us.

With that, I would open it up for questions.

Thank you, sir. At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q & A roster. Your first question comes from Steve Covington with Stifel Nichols and Company.

How surprising, Steve.

Good morning guys.

How are you doing?

Pretty good, how are you?

Good.

Just a couple quick questions. And just to make sure I understood, or I heard this correctly. Did you say that 40 million of the growth came in June, Chuck?

Yeah. Yeah.

And of that 40 million, was any of it of a substantial size, taking up most of it, or was it all just kind of normal-sized credits?

It was pretty normal sized stuff, Steve. This is Mike. We had a couple probably 3, $4 million relationships but it was mostly our kind of wheelhouse kind of stuff, a couple million here, a couple million there. And again, new stuff to the bank, too, which is really, really exciting for us.

That's great. And, Mike, just anecdotally, or, what are your customers telling you relating to the economy? Is it still, you know, cautiously optimistic, are you finally starting to see some of the lines get drawn down?

Yeah, I'd say cautiously optimistic is a good word for it. We're finally starting to see, you know, we had some transportation customers that were really struggling and we're starting to see that stabilize a little bit, although gas prices are always the threat there, but much better than it was six months ago and certainly a year ago.

Great. Chuck, what was the, in the noninterest income category, they had a small item, net gain on sale of loans, is that separate from the mortgage-fee income that you talked about?

Yeah. We sold some guaranteed portions of some SBA loans that we had recently funded.

Is that an ongoing, or in a growing business for you guys?

We do, you know, it kind of goes in spurts. It seems like we'll go a couple quarters and only do maybe one or two and then it just seemed like the last couple quarters we've put a couple of handfuls of them together. So --

Um-hum.

It's hard to judge. It just depends on, you know, some of the customers that we end up bringing into the bank.

Okay. And I don't want to take up all the time, but I, one more if I could. Chuck, you mentioned 32% of the variable rate loans are at floors and then you said 50 to 75 basis points would have to be increased by the Fed for those to go through the floors. Is that after the most recent rate increase that we had, or is that --

That includes it, Steve.

Okay.

So it would need another 25 to 50.

I got you. That's great. Thanks, guys.

Thanks, Steve.

Your next question comes from the line of Barry Mandel with Mandel Money Management.

Hi, guys.

Morning.

Two things. One, your FTEs were up about 10% just in the first quarter, versus the first quarter period end. What kind of future growth do you expect for the rest of this year in terms of FTEs, number one. And number two, how many new hires were loan officers?

This is Mike, Barry. I would say the majority, almost all of the budgeted hiring that we have for 2004, was done in the first half of 2004. That's why you see the FTE increase there, but I also point out that the efficiency ratio continued to trend downward, so it indicates to us that they were good additions and have hit the ground running.

As far as loan officers go, we probably only hired one or two loan officers during that group. We did hire some additional people into our credit staff, which is where eventually a lot of the loan officers will come out of. But a lot of the other hires were really support people we find from time to time when we continue to grow at such a strong rate that we tend to forget that we need to keep the support areas very, you know, at least able to handle the great level of service that we expect.

Okay.

Your next question comes from the line of Brad VanderPloeg with Raymond James.

Thanks, good morning and great quarter, guys.

How do you spell that name Brad?

She must not be from Grand Rapids but I'll forgive her. Chuck, you mentioned a, I think you said a 2.5% average cost on the wholesale funding and I missed where on the curve you're making that estimate, was it two years or 18 months or --

Brad, the current cost is about 2.28%.

2.28. Okay.

Yeah. That's where we're at right now.

And that's a 18-month number or --

The 12-month, what we're trying to do, as we have for the past year and a half, has been trying to extend those maturities out as much as we can, probably a 15 to 18-month average is what we're doing on new funds as well as those that replace maturing funds. And the 18-month rate is about 2.9 right now. The 1-month rate is about 2.5. So somewhere in there is what we're putting on the books currently.

Okay. Good. And then in terms of the new loans coming on the books, you mentioned that the borrowers continue to elect adjustable rates, and I'm wondering how much of that is true election and how much is selling on your part because I would imagine you want to try to get them to take adjustable rates in a rising rate environment and is it getting harder to sell that type of product, or is it truly just the preference of the market still?

That's a good question, Brad, it's Mike. It, we definitely are trying to sell floaters. It's been real easy to sell them for the last couple of years, but we, as a matter of fact, had a board meeting this morning where we're starting to see now some customers requesting either, you know, some sort of cap or, fixed rate options and in our job obviously is to make sure that we price them appropriately and get paid for it when we do put those into effect.

But it is getting harder to sell and the customers slowly but surely are starting to say hey, we better look for some protection in case some of those forecasts are right and we end up looking at a 7% prime here by the end of 2005.

Right. And then, lastly, just in terms of loan growth, I think this is the fourth consecutive quarter that I've woefully underestimated your overall loan growth. And at the risk of being wrong again in the future, is there some reason that I should think that a 70 to $75 million growth per quarter number is not more realistic than a 60, which might have been the historical target?

You know, Brad, I was telling these guys the other day, this is my 28th consecutive quarter of misidentifying what our growth is. It's, you know, every time I say this, it's, you know, it's hard to believe that we can continue on at this pace and Chuck and I were talking. I mean, we internally budgeted this year the most, you know, aggressive loan growth we've ever budgeted and the team just keeps, and our name continues to get out there, we continue to have the opportunities to blow past it. But I hate to start assuming that we're always going to do this type of fantastic loan growth.

I don't know what it is about the month of June but I think this is the third of the last four years that the month of June we just have a tremendous amount of new business coming in and seems like it all gets booked at the end of the month so we end up with a provision expense but not much of the benefit.

Obviously long-term is going to be a great benefit and what's really been good too, is a lot of these new loan accounts, as I mentioned in my comments, have brought in some noninterest bearing deposits along with it as well as some just pure deposit customers have come in, but, you know, I really, and I'm not trying to be evasive even though we should be I guess always in looking forward, but, you know, 70 million, we've done it before. Could it be done again, yeah, it could.

Do I know of anything, you know, any big loans that are pending right now? There really aren't any in that 12 to 15 that I can think of that are imminent, but we clearly are looking at a lot of stuff, it seems like every week.

Right. Okay. Thanks very much.

Thanks, Brad.

Again, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Your next question comes from the line of Brad Ness with FRB.

Hi, guys, how are you doing?

Good, Brad. It wouldn't be a teleconference without you. How are things?

Thank you. Hey, do you guys have the interest margin by month, by chance?

Yeah, we do. But it's really stable, Brad.

Okay. You know, that was actually somewhat surprising to me. I was, I was thinking with what the curve did and being brokered, CDs are priced off the curb, Fed funds didn't move until late in the quarter, I was expecting interest margin to come in, in June. Can you tell me, you know, why that didn't happen?

What do you mean by coming in? Contraction?

Contraction, yeah.

I think a lot of it, I think I touched on it, Mike did, too, is that very significant growth in our demand accounts.

Okay.

You know, noninterest bearing accounts and --

Have you guys done anything differently as far as bringing in those type of noninterest bearing relationships?

I think what's helped us a lot Brad is just again the longer we're into the marketplace the more some of these old-line companies or agencies become, you know, really comfortable with who we are and our size and our ability to handle their service needs. Just continues to build quarter after quarter.

Also what helped our, you know, our spread margin is we generated a lot of loan fees during the month of June especially that, you know, really helped us as we, you know, as we put a lot of volume on to gain those fees in there as well. But yeah, I think a combination of all those things as Chuck mentioned and I mentioned in my remarks were helping us stave off what we knew was a, we kind of call it the twilight zone here, you know, when liability started to trend upward before the assets did, but fortunately now, as Gerry mentioned, we're in a pretty favorable position.

Right. Hey, Chuck, you mentioned that the current brokerage fee rate for 12 months is two five and for 18 months is two eight. Can you compare that to local nonbrokerage fees and what you're seeing from the Federal Home Loan Bank?

They're very close to the Federal Home Loan Bank. They're probably 10 to 20 basis points higher than local rates right now. The competition has been relatively slow to increase deposits rates. Although we're still out towards the top of that we haven't been aggressively raising deposit rates than what we saw certainly with the increase in treasuries and LIBOR rates. So about 10 to 20 basis points higher.

Okay.

Than the market.

And with the Federal Home Loan Bank borrowings you put on, was that similar term stuff, 12 to 18 months?

Actually, we generally go, Brad, we actually go a little bit longer, we usually do 18 to 36 months on the Federal Home Loan Bank.

Okay. And is, are you getting that at, what, those to the 2.5 for the 12-month term that you just quoted, was that, you know, 12 month to 12 month or was that the 18 to 36 that you're getting from Federal Home Loan Bank?

Not quite understanding that question.

For the Federal Home Loan Bank if you're going 18 to 36 months, what type of cost was that for the last quarter?

Actually, we brought most of the Federal Home Loan Bank advances back into early May and really we haven't done an advance in the last two months so I'm not quite sure what those long-term rates have been because I haven't really been looking to those folks for the last two months. But I would say that from what I understand, they're very, and from what I've seen on the shorter end, they're very, very closer to the broker CD rates. I'm sure that, you know, that the two-year is going to be, you know, a little bit north of 3%, you know, probably 3.10, 3.20.

Okay. Cool. Thank you.

Thanks, Brad.

At this time, there are no further questions.

That will conclude our teleconference. Thank you all again for calling in. If you have any additional questions you think of later, don't hesitate to give us a call. Thanks again.

This concludes today's conference call. You may now disconnect.