Mercantile Bank Corp (MBWM) 2005 Q1 法說會逐字稿

Welcome to the Mercantile Bank Corporation fourth quarter earnings conference call. There will be a question-and-answer period at the end of the presentation. [OPERATOR INSTRUCTIONS]

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 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 assumption 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 may access it at 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 thank all of you for joining us this morning. We are very pleased to announce our strongest first quarter ever with earnings up almost 47% over the prior-year period, and assets increasing 371 million or approximately 28%. Strong loan growth, expanding margin, excellent asset quality, and stringent overhead control all contributed to this exceptional earnings performance this quarter.

As you may recall from prior teleconferences, our first quarter is always our most challenging because of officer salary increases which go into effect at the first of the year, as well as the initiation of other accruals as the new year begins.

We've have also today announced a second quarter dividend of $0.11 per share based on our strong first quarter performance. This represents a 10% increase over the $0.10 per share payout of the first quarter and a 22% increase over the prior-year second quarter payout. On an annualized basis, the new dividend rate represents 23% of prior-year earnings, which we feel is excellent for a high-growth banking company such as ours.

At this point I will turn the teleconference over to Chuck Christmas for his comments. Chuck?

Thanks, Jerry, and good morning, everybody. What I'd like to do this morning is give you an overview of Mercantile's financial condition and operating results for the first quarter of 2005, highlighting the major financial condition performance balances and ratios. I think you'll see is the underlying theme of Mercantile's financial numbers reflect a continued successful implementation of our strategy. That being, concentration on business lending, strong revenue growth led by growth of the commercial loan portfolio, high asset quality, and an efficient operating structure.

Our net income for the first quarter of this year was $4.4 million, a 1.4 million, or over 46% increase over the $3 million that we made in the first quarter of last year. On a diluted earnings per share basis, we earned $0.59, and a 44% increase over the $0.41 that we made a year ago.

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

Overall profitability is driven by our continued strong earning asset growth, which is translated into increased net interest income. Further supported by an improved net interest margin. Our net interest income for the first quarter of this year was $12.7 million. That's a 33% increase over the 9.5 million we earned last year.

Our average earning assets for the first quarter this year were $1.51 billion. That is an increase of 315 million, or 26% over the average earning assets of $1.2 billion in the first quarter of last year. Our average loans in the first quarter this year were $1.35 billion. That's an increase of 277 million, or 88% of the increase in average earning assets from a year ago.

Our net interest margin in the first quarter this year was 3.46%. That is up 20 basis points or 6% from the 3.26% we had earned in the first quarter of last year. And is also up 3 basis points that we had earned during the fourth quarter of last year. The increase in the net interest margin primarily reflects the increases in the prime rate, which increases our loan interest income and more than offsets our increased deposit and borrowing costs.

With regard to the margin and looking forward, we've continued to not provide specific guidance, but as in the past, our main issues continue to be loan yields, Federal Reserve action or inaction, and wholesale funding rates. Our variable rate loans at the end of the first quarter of this year totaled 78% of our total loan portfolio, which is identical to where it was at the end of last year. If you remember, just four years ago, only 30% of our loan portfolio was tied to prime.

We've also talked in the past few conferences about the level of variable rate loans at floor. If you remember back then, the first Fed rate increased back in June of 2004, approximately 32% of our floating rate loans were at floors and did not reprice. With the last Fed increase here in March, less than 1% of our floating rate loans did not reprice, so we are certainly past that phenomenon.

Our wholesale -- our cost of our wholesale funds certainly continue to increase as market rates have increased. At March 31st, 2005, the average rate of our wholesale funding portfolio was 2.99%. That is up 34 basis points from where we started the first quarter. The recent increases in interest rates will result in increased cost of wholesale funds.

The next three months we have $170 million maturing at an average cost of 2.3%, and for the last six months of this year we have 330 million set to mature, at an overall weighted average cost of 2.75%. To put that in perspective, the 12-month CD rate is currently 3.75%, but again, I will also mention that that 3.75% certainly has the market expecting continuous increases by the Federal Reserve, the Fed funds rate, and certainly, therefore the prime rate. We continue to believe that we are well positioned for future Fed increases.

Our loan loss provision expense for the first quarter was $725,000. That is a decline of 519,000 from the 1,244,000 that we had expensed in the first quarter of last year. There are two primary reasons for that decline. First is lower level of loan growth in the first quarter of this year compared to the first quarter of last year. Our loan growth this quarter was $57 million, which we are certainly pleased with, but it is the $18 million less than the very robust quarter that we had a year ago when we had grown $75 million. So, again, the lower level of loan growth led to a lower level of loan provision expense.

We also have a lower reserve coverage ratio. Our reserve to total loans at the end of the first quarter this year was 1.32% compared to the 1.38% where it was a year ago. And incidently was also 1.35% at the beginning of the quarter so a decline of 3 basis points for the quarter.

The decline in our reserve coverage ratio results from our ongoing monitoring of our loan portfolio. We continue to evaluate our current loans as -- in concert with our loan review program and we continue to review on an ongoing basis our reserve allocation factors taken into account a multitude of [inaudible].

Although it doesn't involve the loan loss provision expense, I did want to touch at this point in time on the $300,000 accrual that we mentioned in our press release. As was mentioned in the press release, we expensed $300,000 to non-interest expense during the first quarter, for a distressed letter of credit situation. We accrued the $300,000 to account for the estimated exposure in the event that that letter of credit is drawn upon. The letter of credit has not been drawn upon and the borrower is making the required payments. However, in looking at the situation, we decided to establish an increase in accrual to account for the situation.

Our fee income for the first quarter of this year was $1.2 million. That's an increase 171,000 from what we had earned in the first quarter of last year. We had increases in all non-mortgage related activities, which is a very small decline in mortgage loan related fees.

Our overhead costs in the first quarter this year totaled $6.9 million. That is an increase of 1.7 million, or 33% from what we did in the first quarter of last year. However, despite the large increase in dollar volume, our efficiency ratio remained virtually unchanged, 49.4% for this quarter compared to 49% flat for a year ago quarter. Of the $1.7 million increase in quarter-over-quarter expenses, about 52% is in salaries and benefits.

Our FTEs increased from 167 a year ago to 212 at the end of the first quarter this year, that is a 27% increase. Also, as Jerry already mentioned, salary increases throughout the last 12 months. About 9% of the increase in overhead costs is attributable to occupancy, furniture and equipment costs, primarily reflecting there the opening of our Holland office, as well as the aforementioned FTE. And about 10% of the increase is attributable to the aforementioned letter of credit accrual.

The other remaining increases in overhead costs are due primarily just to our increased asset base. As I mentioned, overhead costs increased $1.7 million, however, our net interest income, as I mentioned before, increased $3.2 million or almost twice the growth in our overhead costs.

With regard to asset growth, for the first quarter of 2005 our average assets increased $87 million from the fourth quarter of last year, a 23% annualized growth ratio. And our average loans increased 68 million, or a 21% annualized growth. Our loan growth throughout the first quarter was fairly even with no one month being larger than any other month to a degree. As in the past, we have no major changes in our asset structure with regard to loans, investments, and other assets.

On the funding side, our funding strategy has not changed. We continue to grow local deposits and bridge the funding gap with wholesale funds, that being brokered CDs and federal home loan bank advances.

Our deposit growth during the first quarter of 2005 was fairly flat when compared on an average basis to the fourth quarter of 2004. That is not altogether unexpected as in the first quarter of every year, our business -- many of our business customers make large deposit withdrawals for bonuses and taxes. We have seen very good local deposit growth throughout March and into April, so we certainly expect our local deposit growth to pick up and equal what we've done in the past few years.

As a result of that relatively flat growth in local deposits, we have seen a little bit of an uptick in our wholesale funding program as we continue to bridge that funding gap. During the first quarter of this year our average wholesale funds to total funds equaled 68% compared to 66% in the fourth quarter of last year.

With regard to our capital position, we remain well capitalized for bank regulatory definitions. Our total risk-based capital ratio of 12.7% at the end of the first quarter, compared to 13% at the beginning of the quarter, or a decline of 2%. But again, with our rapid asset growth and expected asset growth, that decline in our risk-based capital ratio is expected.

That's my prepared remarks. I will now turn it over to Bob.

Thank you, Chuck. As Chuck and Jerry mentioned in their comments, Mercantile concluded the first quarter with solid results in terms of the growth, profitability and asset quality. Led by expansion in the commercial loan portfolio, the Bank saw a good balance of growth from existing customers and new customers. Signs which show a gradual rebound in the West Michigan economy from the sluggishness of the past couple of years continue to present themselves.

The loan pipeline remains in very good shape as we head into mid-2005, both in Grand Rapids as well as in the Holland market. We continue to be pleased with our asset quality numbers. Charge-offs, past-dues and nonperforming loans are all better than that of our peer group.

Mercantile's continued success continues to be driven by its focus on the assembly of an extremely strong team of bankers whose daily mission is to provide exceptional customer service. Mercantile seeks out team members, both on the frontline and support positions who can execute this mission. For seven years now, the team has worked diligently to provide this service both to new customers and existing customers attempting to earn their business and their trust.

Regarding facilities plans, work continues on the construction of Mercantile's new downtown Grand Rapids main office at U.S. 131 and Leonard Street. The facility is nearly complete and will be operational with a move date scheduled for next month.

That's the extent of my prepared remarks. With that, I turn it back over to Jerry.

Thank you, Bob. And with that, we would be happy to entertain any questions that you might have.

[OPERATOR INSTRUCTIONS] Your first question comes from Kevin Reevey of Ryan Beck.

Congratulations on a nice quarter. Chuck, could you give us some color as far as the increase in your staffing, how much of that was due to hiring of loan officers versus non-loan officers?

Kevin, I think it was pretty much across the board. We continued to certainly, as Bob mentioned, hire lenders and other sales folks as they become available to us and want to join our team. But as I've always said, one thing that we are -- we do have to have a relatively efficient operating structure, but one thing we do not do is cut corners when it comes to our back room operations, if you will. So we continue to hire in our deposit operations, loan operations, credit area, accounting and auditing, so I think the hiring that we talked about is pretty much across the board.

And then I notice that your effective tax rate jumped up in the first quarter relative to the fourth quarter. Going forward, should we be using this higher effective tax rate, or is this a one-time event here?

No, actually, the tax rate that we have for the first quarter, Kevin, is what you should use going forward. If you remember in the fourth quarter, we had some tax credit accounting go through, and that had effectively lowered our tax rate for the fourth quarter alone, but it was just a fourth quarter phenomenon and not a first quarter.

And then my last question is related to nonperforming loans in OREO, I noticed there was a sizable jump up. Can you give us some color as to what was going on there?

Kevin, this is Bob. The OREO was the continuation of the work-out process for the one credit that we mentioned previously. That's been in our nonperforming loan list and the is now in ROE [ph], and we hope to have that as well as another distressed real estate loan resolved within the second quarter.

Thank you.

Your next question comes from Steve Covington of Stifel Nicolaus.

Good morning, guys. And again, congratulations on a great quarter. Chuck, do you have the -- both the loan growth and the net interest margin by month handy?

No, I don't have that handy. It was fairly equal through the quarter though, Steve.

Was it, okay. I know you talked --

Margin was down a little bit in January only because we didn't have a Fed increase that month, but other than that -- I know loan growth was steady, and I think overall the margin was as well.

Jerry or Bob or Mike, could you give us a sense of the competitive environment up in your markets and anything new, any competitors do anything different or crazy?

Steve, this is Jerry. Nothing really new, but it remains highly competitive. We go after the same deals that the fifth thirds of the world, the Nat City's, the Huntington's, Standard Federal's, JPMorgan Chase, so it's highly competitive from a rate standpoint. I think it will always continue to be that way. We win more deals than we lose, but price is always an issue, personal guarantees are an issue, collateral formulas are an issue. So it's tough competing, but we think we do better than our competitors. As I said, we win more than our fair share of deals.

Steve, this is Bob. Just to add more even to Jerry's comments, is that you have the typical big bank strategy of what's their hot button for the week and what product they're going to try to push and they come out and have some attractive things for 30 days and they pull in the horns, and customers are pretty savvy to that. They realize that that's not really going to work in this market too much anymore, but it is highly competitive in both big banks and small banks all together.

Has your Holland experience continued to be very solid?

Yes, it's been very good. We've had really good growth rate there in the loan portfolio, great pipeline as well as landing some good core deposits over there. It's been going great.

Good. All right, guys. Thank you.

Thanks, Steve.

Mr. Vandenhof, you may state your question.

First of all, great quarter, Jerry and Chuck.

Thank you, Frank.

A couple of questions. On that letter of credit, the $300,000 accrual for estimated loss, is there any chance of recovering part of that or all of that?

This is Bob. That is really the same strategy that we use for any of our distressed loan analyses. The reason why it was different is because it was a letter of credit and we cannot account for it in the loan loss reserve. As far as recovering that, we set the accrual based on our analysis of the present situation. As it gets better or gets worse, we will continue to make adjustments, but it is really an ongoing situation.

And the loans are current.

The loans are current, [inaudible] are performing. It's our attempt to make sure we have a conservative estimation of the loan situation as it stands right now.

Second question, your nonperforming assets were up a couple of million dollars. Is that related to a particular loan, or have you got several that have contributed to that?

It's really ongoing ebb and flow of watch lists. And as you recall last year, we had a little bit of an increase in the second quarter, and then it dropped the rest of the year and now it's up a little bit. You're going to have that as the economic cycle works its way through and companies react to that.

A third and final question. It's nice to see the cash dividend get increased on a regular basis. And the most important question for Jerry is, in past years, if you declared a stock dividend, when was that done? Was that done in May?

We typically had declared it in the first quarter. I think last year we declared it in the second quarter, and we have not yet decided. As we look at managing our capital, we look at stock splits, cash dividends, stock dividends, and at this point in time, based on the strength of our first quarter earnings, we felt an increase in the cash dividend was an appropriate strategy.

As we've looked at increasing shareholder value, for your investors, you look at price appreciation, and you look at multiple expansion. And what we have found is that cash dividends have resulted in substantially greater long-term multiple expansion than the stock dividends have. The stock dividends give us a little boost, but if you look out six months, the multiples are just about back where they were when we declared the dividend. That doesn't mean that we're never going to do a split or a stock dividend. Obviously, stock dividends are advantageous to us because they increase our float and retail customers like them.

So are we going to do one or not? I can't give you an answer on that. We felt at this time that based on our performance and the impact that cash dividends have had on our multiples that an increase of 10% or so in the cash dividend was the right strategy.

That's a good move. Appreciate that. What would -- what price range would you like to keep your stock in? In other words, at what level would you say, it's time for a three for two split, or something like that?

You're not going to pin me down on that one, Frank, but good question.

Tried.

I know. You're good at that.

Okay. Thank you, and a great quarter. Keep up the good work.

Thank you, Frank.

[OPERATOR INSTRUCTIONS] Thank you. Your next question comes from Paul Wu of FBR.

Good morning. Congratulations on a great call.

Thank you.

I had question on the loan growth slowing down. Is there a specific reason for it, and what should we expect going forward?

Paul this is Bob. It is really less -- the first quarter last year was extremely strong, as Chuck mentioned in his comments, this year's first quarter growth, $57 million, is one that we're very pleased of. The pipeline remains very strong, and as we are a commercially focused bank, the timing of bringing deals to closing and funding them varies from month to month, quarter to quarter, so you see some fluctuation from time to time. But overall we're very pleased with the potential that's out there, as well as our first quarter performance.

And we do have a strong pipeline.

Very strong pipeline.

Okay. So it's just a quarterly trend downward. In terms of the wholesale funding model, what should we expect with the efficiency ratio going forward? Are you projecting improvements?

Yes, I think one of the things with the efficiency ratio, we certainly want to drive that down as much as we can. We're certainly going to work ourselves to do that, although service is obviously paramount to our overall operating strategy as well, and there's obviously some cost/benefit relationship there. But we certainly think we can get the efficiency ratio down say maybe into the mid-40% over the next two to three years. Again, I think as we talk, we think if you drive it down much more than that, service is going to suffer and we're not going to allow that to happen.

Efficiency ratio is obviously a function -- a big function of overhead costs. We think we do a very good job at managing those overhead costs. We don't have a lot of building projects slated for the near-term future, so no significant increase as a result of that. But we will certainly continue to add people as they become available to us and as we need them in our back room operation.

Obviously, another important aspect is our margin, and we've obviously improved our margin quite significantly over the last 12 to 18 months. And we have obviously positioned the bank well, we believe, for future interest rate increases and I think we're probably going to see them at least in the near term. So I think the efficiency ratio should do well on near term and long term.

Chuck, I missed some of the maturity of the wholesale borrowings. You had mentioned 170 million maturing -- ?

Yes, we have 170 million maturing in the second quarter.

Second quarter, okay. And then the 330?

330 million maturing in the last six months.

Last six months, okay. And then has the duration changed?

Yes, we're probably at right around 11 months right now. And historically, we were up between seven and nine months. It's something that we continue to do is try to lengthen the duration of the CD portfolio.

Okay. Great. Thanks.

Thanks, Paul.

Thank you. Your next question comes from Brad VanderPloeg of Raymond James.

Thanks. Good morning and congratulations. Another question about this letter of credit. It sounds like this is an existing relationship to whom you have loans outstanding already, and this is just a letter of credit that hasn't been drawn down yet. Is that right?

Yes.

Bob, as you said, it can't go through the loan loss reserve at this point, but it would at some point if they drew down that credit and it became an issue?

Yes. The reason why it has to be accounted for the way it is now is because it is not an outstanding loan obligation, but if it were to be drawn, then it would be treated like any other normal outstanding loan with accounting for in the loan loss reserve.

Brad, what we would do is if it was drawn upon, we would transfer the dollars in that accrued liability over to our reserve.

Okay. Got it.

If you're comparing reserve expense, you can really think of that 300,000 as something that would have been in our allowance expense, but as Chuck and Bob mentioned, accounting just does not permit us to do that.

Got it. Good. Thanks. Then quick question about the wholesale funding market, Chuck. I was wondering if you've noticed any changes as rates are going up here and deposit competition gets more intense, if there are any changes in the dynamics, either pricing or availability of wholesale funding in terms of spreads or timing or anything like that.

Actually, the market is -- remains extremely liquid and actually extremely cheap. It always gets a little expensive at quarter end as everybody starts trying to window dress their balance sheets. But again, as I mentioned before, our main competitor really is the stock market, and with the stock market still struggling along, a lot of people are still wanting to put a big percentage of their funds in CDs and money market accounts. And the spreads are still extremely low, as I mentioned before also, the average spread is probably 60 to 70, 75 basis points over Treasury rate. Right now we're running at about 25 basis points. From a spread standpoint it is still extremely cheap.

Right now there's not very many banks out there trying to get CDs, so that's helping the spread as well. And right now there's a very major shortage of product. We've got brokers calling not only us but other banks as well with a big shortage of product. So it remains very liquid and I think relatively cheap.

You say a shortage of product. You mean a shortage of demand for the product?

No, shortage of banks, shortage of supply. Shortage of banks like Mercantile out there trying to raise money.

Right. Very good. Thanks.

Thank you, Brad.

Thank you. At this time, there are no further questions.

Very good. We want to thank all of you for listening in. If you have additional questions that you think of later, please don't hesitate to give Bob, Chuck, or myself a call. Thank you again. Have a good day.

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