Mercantile Bank Corp (MBWM) 2005 Q4 法說會逐字稿

Welcome to the Mercantile Bank Corporation fourth quarter and full-year earnings conference call. [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 the 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 Bank today you can access it at the Company's website, 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, 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 good morning, everyone. Thank you for joining us. We are pleased to report this morning another excellent year of earnings, earnings growth, balance sheet growth, and outstanding asset quality. 2005 was somewhat of a watershed year for us as we expanded the Mercantile business model into the Lansing and Ann Arbor markets. Notwithstanding these aggressive moves into new markets earnings per share was up 25.5% over 2004 adjusted earnings and Chuck will mention more about that in just a few minutes.

Although earnings growth in the fourth quarter was relatively flat, up 1.7% over the fourth quarter of last year, I think it's important to note that we incurred significant start-up costs in our two new markets. Also, and I think very importantly, we opted to enter these markets fully staffed with city presidents, senior lenders, mid-level lenders, consumer lenders, mortgage lenders, business development and credit support, full-service branches, and all the other personnel who would ensure that the service levels that have made us so successful in west Michigan would be duplicated in our new markets. Notwithstanding these expenses however, we still experienced earnings growth in our last two quarters and ended the year with an efficiency ratio not much higher than at year-end 2004.

As you can see from our press release we are already successfully leveraging our investment in Lansing and Ann Arbor and I'm sure Mike will have a couple of comments on that as well. We've had great loan and core deposit growth and we have significant backlogs in both markets. In other words, we believe that the successful leverage of our investment in these new markets in 2005 will continue to improve as we grow our organization in these new markets in 2006. It will help us maintain our strong balance sheet growth and more importantly provide an ever more significant contribution to our bottom line with minimal increases in staffing and other costs this year. Not only will these new markets contribute to our earnings and asset growth in 2006 they will also serve to diversify our portfolio mix into other non manufacturing economic sectors.

My last comment deals with some investor and analyst concerns that we discussed with many of you during this past year regarding the banking industry and the flattening or declining interest rates in the latter half of 2006. While I'm not making any prognostications, I do suggest that if you have followed Mercantile Bank Corporation for the last five years you will note that our earnings have increased significantly in each year notwithstanding the direction or lack thereof of interest rates. We are very good at managing interest rate risk. Secondly, our anticipated continued strong asset growth both in west Michigan and our new markets will have a very positive impact on spread income and we expect asset quality to remain very strong. Thirdly, I already alluded to the benefits that we will also realize from our geographic expansion and its positive impact on our portfolio mix.

And my closing remarks, we feel that 2005 was one of our best years since our inception eight years ago, and notwithstanding the challenges that face all of us in the banking industry we feel very positive about 2006. With that I will turn my remarks -- or the conference over to Chuck.

Thank you, Gerry. Good morning, everybody. What I'd like to do is give you an overview of Mercantile's financial condition and operating results for the fourth quarter of 2005 and all of 2005, highlighting major financial condition and performance, balances, and ratios. But as you will see the underlying theme of Mercantile's financial numbers reflect the 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 an efficient operating structure. And our financial results continue to reflect a significant provision expense necessitated by our strong loan growth as well as, and as Gerry mentioned, our initial overhead cost associated with our expansion into Lansing and Ann Arbor.

Before discussing specific results, please be aware that we're comparing all of 2005 with 2004. I will be excluding the write-off of issuance costs associated with the 1999 issuance of trust preferred securities which were redeemed in September of 2004. The $845,000 one-time charge equated to $548,000 on an after-tax basis during the third quarter of 2004. Our net income for the fourth quarter of 2005 was $4.55 million, or about $60,000, or 1.7% over what we earned in the fourth quarter of 2004. For all of 2005 our net income was $17.9 million, an increase of $3.6 million, or about 25% above the adjusted $14.3 million in 2004. Our diluted earnings per share in the fourth quarter of 2005 totaled $0.59, about 1% above the $0.58 we reported in the fourth quarter of last year, and for all of 2005 we earned $2.31, an increase of 25% above the adjusted $1.85 we earned in all of 2004.

Our strong increases in net income and earnings per share continue 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 offsets the growth in overhead costs and the significant loan loss provision expense due to continued strong loan growth. Our overall profitability is driven by continued strong earning asset growth which is translated into increased net interest income further supported by an improving net interest margin. In the fourth quarter of 2005 our net interest income totaled $15 million, a 24% increase over net interest income of 2004 in the fourth quarter, and for all of 2005 our net interest income totaled $55.3 million, an increase of almost $13 million, or about 30% over what we earned in all of 2004.

Our average earning assets during 2005 totaled $1.61 billion, up almost $300 million, or 23%, from average earnings assets during 2004. Average loans were up $255 million during that time frame, or about 85% of the increase in average earning assets. Our net interest margin for all of 2005 came in at 3.50%, and that was up 20 basis points, or 6% from the $3.30 we earned in 2004. Overall, our improved net interest margin during the past year is due to the overall positive impact of increasing interest rate environment with our asset yields increasing faster than our cost of funds. Our net interest margin was fairly consistent throughout 2005 and on a quarterly basis had a low of 3.46% and a high which was the last quarter of 3.54%.

As always, we do not provide specific guidance with regards to our net interest margin or our profitability, but certainly as in the past our main issues with regards to the margin will be loan yields, the Federal Reserve, and wholesale funding rates. At year end 2005, about 73% of our loans were floating rate compared to 78% a year ago. So a small decline but obviously a vast majority of our loan portfolio continues to be floating rate. About 35% of our floating rate loans have ceilings. That equates to about $1.1 billion. At the last fed increase back in December, about 7% of that portfolio, of the floating rate portfolio, did not increase, and another 3% did not increase for the last time. So about 10% of our portfolio is now at its ceiling. However, that means that 90% of that floating rate portfolio, or about $1 billion, is still subject to future increases as the prime continues to go up.

Our cost of wholesale funds have increased and it will continue as maturing funds are replaced with funds at higher rates. In the first six months of 2006 we have approximately $435 million maturing at an overall cost of 3.6%. And in the last six months of 2006, we have another $315 million maturing at an overall cost of 4% even. In total, our wholesale funding portfolio equals $1.1 billion with an average cost of 3.90%. Our 12-month -- the 12-month average rate right now is about 4.7%, but it is also important to note that that 4.7% does factor in future expected fed increases.

Our loan loss provision expense during the fourth quarter of 2005 was $1.3 million, an increase of $300,000, or 27% from the fourth quarter of last year, representing an increase in loan growth from quarter to quarter. For all of 2005, our provision expense totaled $3.8 million, that is a decrease of $900,000, or 19%, from what we expensed in 2004. We did have reduction in our provision expense from last year compared to 2004 and it is a combination of several factors. One being a lower coverage ratio with our reserves to total loans at 1.31% at the end of '05 compared to 1.35% at the end of '04, slightly lower loan growth, and despite an increasing balance of our loan portfolio, our dollar amount of actual charge-offs were down $151,000 in 2005 versus 2004.

Our noninterest income in the fourth quarter of 2005 totaled $1.9 million, about $800,000 higher than the fourth quarter of 2004 and for all of 2005 totaled $5.7 million, about $1.4 million higher than all of 2004. As we noted in our press release, during the fourth quarter of 2005 we did have a one-time fee of approximately $700,000 relating to the sale of tax credits that we garnered through the construction of our lender facility. We also had increases in virtually all fee producing products and services which also enhance our fee income. With regards to noninterest expense during the fourth quarter of 2005 we also had some one-time costs associated with leaving our former main office on division street. Those costs totaled approximately $300,000 and were generated through a termination of our lease as well as the elimination of our leasehold improvement. I will excluding that $300,000 from the further discussion.

Excluding those costs, overhead costs in the fourth quarter of 2005 totaled $8.5 million, an increase of about $2.3 million from 2004, and for all of 2005, our overhead costs totaled $30.8 million, a $7.6 million or 33% increase over 2004. However, that $7.6 million is well below the increase in net revenue that we had during 2005 which was up $13.8 million. So again, our increase in net interest income continues to far outpace any increases in overhead costs. Our efficiency ratio for all of 2005 came in at 51%, higher than the 48% of 2004 but again primarily generated due to our expansion into the two new markets.

With regards to our growth in overhead costs, of the $7.6 million increase in 2005 over 2004, $4.7 million, or 62%, is in salaries and benefits. Our FTEs increased from 194 at the end of '04 to 273 at the end of '05, a 41% increase. Occupancy and equipment costs were also up $1.6 million, or 21% of the growth, reflecting the opening of our Holland facility, the move to our new headquarters on Leonard Street, as well as Lansing and Ann Arbor. Other overhead costs were also up but due primarily to an increased asset base.

At the end of '05 our total assets equated to $1.84 billion. During the fourth quarter we increased assets of $41 million. However, loans were up $73 million, the difference being taking fed funds sold and using those monies to fund loans. For all of 2005 our assets were up $302 million, or about 20%, with loans up $245 million, or about 19%. Again there are no major changes in our asset composition. With regards to funding, our funding strategy has not changed as we continue to go local deposits and bridge the funding gap of wholesale funds, that being broker CDs and federal home loan bank advances.

We had very strong local deposit growth during 2005 as our local deposits including our repurchase agreements were up $84 million, or 19%. Our wholesale funds to total funds at the end of '05 totaled 68%, a slight increase from the 67% level at the end of '04. With regard to capital, the bank continues and the Company continues to be in a well capitalized position with a total risk-based capital ratio at 12% at the end of '05. That's my prepared remarks. I'd certainly be happy to answer any questions in the Q&A session. I'll now turn it over to Mike.

Thanks, Jeff. Good morning, everybody. As already mentioned in our press release and by both Gerry and Chuck, 2005 was yet another very successful year for Mercantile Bank Corporation. I'd like to put the success of the bank in context a little bit. I'd like to mention the FDIC's deposit market share report for Kent County as of June 30, 2004, which was released during last quarter. This report showed that in less than seven years, Mercantile Bank had captured 12.5% of the Kent County market, effectively becoming the second largest bank in the County by that measurement. This phenomenal growth and the excellent asset quality at a company that has become a hallmark of Mercantile and the blueprint for expansion beyond our west Michigan roots.

2005 was noteworthy for many reasons but especially our investment into the Lansing and Ann Arbor markets. 2006 is the year we plan to leverage those investments in a very aggressive way, just like we have done in western Michigan. I believe we are well poised to do so with our team of bankers and our strategic vision. As always I will be glad to answer any questions later, but at this time I'm going to turn it over to Bob Kaminski.

Thank you, Mike. Mercantile indeed finished out 2005 in strong fashion. Asset quality remains quite strong. Past due, nonperforming loans, as well as charge-offs continue to run at superior levels to that of our peer group. Through the various economic cycles over the past eight years, Mercantile has consistently maintained a strong asset quality. In addition to maintaining our rapid pace with continued loan and deposit growth, in 2005 our staff was able to successfully open two new full-service banking offices in new markets. This was done effectively and efficiently during the summer months concurrent with the opening of our new main office in downtown Grand Rapids. Furthermore, strong growth in the Mercantile investment center, payroll processing, and the new health savings accounts continue to facilitate the garnering of new banking relationships and the bolstering of existing ones.

Looking ahead as we move deeper into 2006, customer initiatives include the growth of our remote deposit capture product, the rollout of our next generation Internet banking product. Traditionally, in support of the growth in our mid-Michigan market we will begin construction on a permanent headquarters in Lansing likely to be completed by mid-2007. Those are my prepared comments. I would be happy to answer questions at the end of the discussion and I will now turn it back over to Gerry.

Thanks, Bob. And at this point we would be happy to take your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from John Rowan.

Good morning, everyone. I guess my first question would be for Chuck. The higher tax rate, about 250 basis points is that what we should use going forward?

Yes.

So 33%. Okay. Then the next one, Chuck, do you have a number for the average interest-bearing liabilities for the quarter?

I don't have that, but John I can send that to you via an e-mail.

And then just one more question, probably for Bob. Can you just give us some color on the jump in nonperforming loans in the quarter?

Well, as you know, nonperforming loans tend to move in ebbs and flows, and up and down, and we were about the same at the end of this quarter as we were at the end of the second quarter. We did get a nice drop in the third quarter as workouts continue to proceed to the cycle of a workout loan those things are going to happen and you're going to have some ups and downs from time to time. So nothing more than a normal cycle.

Okay. Sounds good. That's all my questions. Thanks.

Your next question comes from [Howell Ridley].

Great quarter, guys.

Thanks, Howell.

Keep up the good work. As I told you before, it would help if you would lower the price so I could buy some more, and you accommodated me. Two basic questions. Number one is, could you give us a little bit of dollars in regards to your growth or where you stand in Lansing and your new Ann Arbor market? And secondly, just a comment, and you may be able to comment on it, possibly the bank might entertain a stock split at some time to get more shares outstanding as well as possibly more trading. And I just -- you may have a comment on that, and you may not.

Howell, this is Mike. I'll take the first part of your question. At the end of the year, Lansing was about 20 million, a little over $20 million in assets, and Ann Arbor was a little bit behind that, with both of them had real strong backlogs that we're already starting to see come to fruition in January and February and March are looking very good as well. So for the relatively short period of time those two markets were open, we're very happy with what they did and where they're going. So for the second part, I'll let Gerry or Chuck handle it.

Howell, appreciate the question. The number of shares outstanding and trading volume are something that we look at all the time, and obviously, the better the investment, the more float, the more trading you have, and we're very cognizant of that. We have made no decisions insofar as stock splits one way or the other. We think the price -- actually, we think the price is too low where it is right now. But from a multiple standpoint, as we take a look at it, we really haven't reached any conclusions as to when or if a stock split would make sense. If you were an investor in the old FNB Company, which I think you were, every time that stock got to $30, they had a 3-for-2 split. And we think there's some cache really in a stock price in the 40 to $50. Obviously in years past we've had a 5% stock dividend, which has helped a little bit. But I guess the long way around, although we're not doing anything at the present time, I do want you to know that we are cognizant of that and do look at it frequently.

Well, thanks for your reply, and also I wanted to tell you as you know, I'm located in Ann Arbor, the gentleman you selected to run your Ann Arbor operation is very, very highly respected in this area. A lot of people I know know him.

Appreciate it. That's good to know.

Your next question comes from Brad Vander Ploeg.

Good morning, guys. Great quarter. Congratulations.

Hi, Brad.

Real quickly, just on a couple of items here, the tax sale credit on a pretax basis about $700,000, and then you mentioned about $300,000 in lease termination fees. Both of those were all in the fourth quarter, correct?

That's correct.

Okay. So if I was to look at that as a net benefit to you of about $400,000 pretax, is there anything else in the quarter that might have offset that, just thinking about it on an ongoing basis?

No, I think those were pretty much standard loan issues.

So if I were to look at that going into the next quarter and the core earnings power, that might suggest that it's actually a little bit less than what you reported in the fourth quarter. Would that be right?

Yes.

Okay. All right. Just wanted to make sure I understood that. And then into the -- just talking about the economy in general, Bob and Mike, you touched on this a little bit, but maybe if you could just add a little bit more color on any changes you're seeing in particular industries. I know eastern Michigan is having a lot of trouble, but I didn't know if there were any significant changes in the furniture industry or trucking or anything like that that either have you concerned or optimistic that would be a change from last quarter.

Hi, Brad this is Mike. I will be glad to try to answer that for you. It's kind of a mixed bag out there right now. You touched on a couple of things. For example, the office furniture, which is really big for us in our west Michigan markets, that's got a nice slow and steady recovery, so that's good to see from the standpoint there's not a lot of hiring going on back in that area or tremendous sales increase in work coming out of there, but the main thing is that the bleeding seems to have stopped, and that in itself is significant for us.

That has also helped another industry that we were -- we had a pretty good exposure to, and that's the transportation industry. We've mentioned a couple of times in these teleconferences that over the last three or four years we've kind of weeded out a few in that industry, and what we had, and we've reduced our exposure there, but the ones we have in that industry are far more healthier now than they were a year or 18 months ago, so that's a good thing. Part of that is tied to the fact that the office furniture industry in west Michigan has stabilized. The biggest issue that we continue to watch are the automotive industry, especially in Ann Arbor and Lansing, but even in west Michigan here, the whole issue with Delphi and Meridian and some of these big players that are struggling, they do have impact on some of our customers, but not to the extent that you might think they would to a $2 billion bank, only because we've been very cognizant of those industries struggling for a long time now, so before we get involved with people that are too heavily involved with those particular players, we try to do an extra amount of due diligence.

As you know, looking at our asset quality to begin with, we do a lot of due diligence before bringing any sizable credits on, but that being said, we've got a handful of credits that are touched either directly or indirectly through some of the things going on with Delphi especially, and we continue to work through them. Nothing that's catastrophic, nothing that -- to give you an example, or related to an earlier question in this conference, nothing that's really made anything matriculate into the nonperforming assets. They aren't related to that. But we continue to watch that particular industry pretty closely. Did that answer your question?

Thanks. Just real quickly on industries again, a lot of time is spent on what's not doing well, but maybe you could just touch on some areas that maybe are doing better than expected and growing well or is your growth still primarily market share gain driven?

Well, that's a great question on a couple of levels. One of the things that doesn't get the headlines, and it's just natural human nature and the natural ways of the press, is that there's an awful lot of things going right in our market, and we've got a good cross-section across the board. There's a lot of good smaller to medium-size businesses, a pretty good cross section of industries that continue to do very well in west Michigan. Our new markets that we're in, Lansing and Ann Arbor, the staff that we've hired there have some very good contacts, again, across the board in many different industries, so we're doing well. But we continue to see that probably our greatest gains the last five years, especially, well, really since we opened the door, has been the increase in market share that we've been able to take away from the competition.

Goes back to some of my comments I made earlier. When we opened the doors eight years ago if someone had said, by the end of June in 2004 we would be the second largest bank in terms of market share in Kent County, I probably would have fainted, as aggressive and optimistic as we were, so that kind of gives you color of where that comes from. That certainly isn't stopping. We have lots of opportunities because of things going on with some of our larger competition, so it's across the board, but I can't say there's one industry that we've said, boy, we're going to hitch our wagon and ride that industry. That's not our nature anyway, because as we look at loans, we try not to do it so much by industry as we do by its strength, the management, and the ability of the companies that we're looking at.

All right. Very good. Thanks very much.

Thanks, Brad.

Your next question comes from Christopher Nolan.

Hi, guys great quarter.

Thank you.

Chuck could you go through that quick -- that wholesale funding maturation reschedule? You sort of went through it quickly.

First six months of 2006 it's 435 million at a cost of 360. And in the last six months of this year, it's 315 million at 4%.

That's the last six months of 2006?

Yes.

Great. And obviously going forward, I mean, past comments was expectations that the margin might be coming under pressure because of the flat yield curve. Is that the expectation?

I think, Chris, the biggest issues with regards to our margin is what's the -- what the fed is going to do and obviously how that impacts prime. As long as the fed continues to increase interest rates, that's a benefit to our margin, because of the high level of our assets and obviously our loan portfolio tied to prime. I think the issues that are out there, and I think the issue is certainly there is that once the fed stops increasing interest rates and our asset yield level is up there's certainly going to be a continuance of an increase in the cost of funds which will put pressure on our margin. So I think that timing issue and obviously that's the main reason why our margin has gone up like it is, it's more of a timing than certainly a change in asset structure or liability structure or anything like that. I think that is a much bigger issue than the shape of the yield curve. As you know our balance sheet is very short term, not only with the floating rate loans but also our liability structure. So it's more of managing through what the fed does and doesn't do than the actual shape of the yield curve itself.

Obviously then that puts a higher emphasis on strategic vision and moves in 2006 because assuming the fed stops raising rates early in 2006, earning asset growth has to take over. Gerry, do you have any sort of comments that you can provide us in terms of what the vision is for new markets?

Yes. And if you look at our past history, we've tended to operate in a relatively narrow band from an interest rate spread and margin standpoint, and in times when our margin and spread have been under pressure, we've really offset that challenge by the growth in our balance sheet. And one of the reasons that we have gone into these two new markets, as well as Holland, is just for that reason, to not only diversify our portfolio, but to continue the excellent asset growth that we've had. And so certainly 2006 will be challenging from an interest rate/risk management standpoint, but again, if you look at our history you'll see that we tend to manage through those times very well, and this time around, not only do we have our west Michigan market, which is extremely vibrant, but we've got two great new markets to provide additional loan growth to help us offset any margin compression that we realize.

So for 2006, growth would be mostly realized within these markets that you've just expanded into? Won't be any new markets?

No, I think -- we really hadn't planned to do two in 2005, but we had the opportunity -- you can't say never, but what we really are looking at, as I mentioned in my remarks, I think all of us did, is really leveraging the upfront costs and the staffing costs that we realized already. As I said, we started with full staffs in both of these markets, and obviously we could have started with fewer people, but our brand is service. So we will have many fewer hires. The recruiting fees, et cetera that we paid in 2005 and substantial amounts will be much less, and so we look really to leveraging -- and I guess I can kind of segue into another comment, and that is not only do we see the balance sheet growth helping offset any contraction margin, but we can really leverage these costs and continue to put a lot of -- exert a lot of downward pressure on our efficiency ratio.

Got it. Final question is, as you look forward towards a more balance sheet-driven growth phase, within the next year or so, is there a particular floor in terms of the capital ratios we should be looking at where you prefer them not to go below, or you are considering raising additional capital?

This is Chuck again. What we have to do, as we always have in the past, is look at that total risk based capital ratio which, as I mentioned, was right at 12%. The bank runs about 20 basis points lower than that, and obviously we need to keep the bank in a well capitalized position because our use of brokered CDs. So that's kind of the bogey that's out there, I think everybody realizes that. We cannot allow that ratio to drop below 10%. So I think if -- when we get around that 11% level we start talking to our investment bankers, Board, and executive management starts talking about the different ideas, looking at the markets, and making a determination of what we need to do probably within the next 12 months from that point in time.

Okay. Thank you.

Thanks, Chris.

Your next question comes from [Paul Wu].

Good morning, guys.

Good morning, Paul.

Quick question for Chuck. You -- just to make sure I got the numbers right, you had mentioned 1.1 billion in brokered time deposits?

That is brokered and Federal Home Loan Bank.

And Federal Home Loan Bank. Okay. Then the 4.7%, is that the one-year brokered CD rate?

That is correct.

Do you have a corresponding local one-year CD rate?

It's about the same. It's a pretty high-priced market with regards to deposit rates over here, especially when you're looking at the larger 100,000 and over CDs and public unit CDs. Those pretty much track with the brokered rate.

Then the fourth quarter with the state tax credit, is there any other thing that carries over? Do you have any more additional tax credits?

Nope. Everything took place in the fourth quarter and nothing before that and nothing thereafter.

Okay. Efficiency -- excluding the 300,000 lease termination, I think the expenses were in line, and the efficiency ratio looks great. Going forward, are we expecting any additional expenses with expansion, or had they all been run through an entire quarter?

I think if you look at the fourth quarter I think they're pretty much in there, excluding the one-times that we talked about, especially with regards to the ramp-up of staff and the two new markets and some of the hiring that we did here in this market as well. So I think the fourth quarter is a pretty good core number to use going forward, and obviously just, as always, the pay raises that take place at the first of January for all officers.

Okay. Great, thanks.

Thanks, Paul.

Your next question comes from [Barry Vindel].

Couple of questions, guys. One, since mentioned pay raises, can you share with us what the average pay raise was we expect to see in the first quarter?

I think we used the target around 4% this year.

Okay. In '06, what are your plans -- I know you grew FTEs quite a bit last year because of the expansion. What are your plans in terms of '06 for FTE growth and what are your goals in terms of either efficiency ratio or operating expense growth in '06?

Well, FTE growth is going to be significantly less than it was last year. As has been the theme from all of us this morning. The term this year is leverage for us, to leverage bad investments. So you're going to see, I mean, we hired, as Chuck said, well over 100 FTEs last year. It's going to be a fraction of that this year. Our plans don't call for very much in the way of additional FTEs from there. So you can kind of take that and extrapolate what that will do based upon our historical growth that we've done pretty consistently since we started the bank and come up with a pretty good number of what that efficiency ratio is. Obviously our goal is to drive it as low as we can without impacting customer service.

Right. Well, can you - you do believe in '06 you can get the efficiency ratio back to where it was in '04?

Barry, this is Chuck. Obviously part of that equation is going to be the net interest margin and obviously a lot of that has to do with what the Federal Reserve intends to do, especially here in the first quarter. But I think that just from an efficiency standpoint of operating costs we're certainly not going to have the growth that we did in 2005 and 2006. But obviously the efficiency level is also going to be driven by the margin.

Right. What about, Chuck, what about loan caps? You mentioned 100 million in loans that hit their caps. Can you kind of go through the next two quarter point increases how much in the way of loans will hit their caps at that point?

I would guess -- Barry, I don't have in that front of me, probably somewhere between 30 and 50 million per increase, per 25 basis points. There's certainly more loans that will be hitting their caps as the fed continues to increase but still an overwhelming majority of our floating rate loans will continue to reprice.

Okay. What about the profitability in terms of Lansing and Ann Arbor, each of them? Do you expect them to be at break even by the end of the year based on what you know today?

Based upon what we know today that's a good target and a good goal for us and we would expect that, yes.

Okay. Thank you very much.

Thanks.

Your next question comes from Bryce Rowe.

Good morning, guys.

Good morning.

Chuck, just a couple of housekeeping questions for you, and then one more question beyond that. What was the tax equivalent adjustment for the quarter?

In dollar amount?

Yes.

Let me calculate that. About 295,000.

Okay. And the balance of average securities, total securities for the quarter?

I can shoot you an e-mail. I don't have that specific information in front of me, Bryce.

Okay. Then just a bigger picture question for you guys. Considering the increase in the cash dividend, how do you guys -- what's the thought process behind that considering that you guys are net consumers of capital?

This is Gerry. I can answer that. When we decided to start paying a dividend three years ago, it was a tough one for us because obviously we are as you said, net consumers of capital, and the thought of going out and doing capital raises, turning around and starting to dividend some of that back was a little tough to swallow, but we did it for a couple of reasons and continue. We tried to enhance the dividend as much as we can. If you look at the payout in relation to prior year earnings it's somewhere around 20, 21, 22%, and we try to keep it in that area. The dividend yield roughly 1% depending on the stock price. One of the things that the dividend did for us was enable some other institutional investors who were precluded by policy or philosophy from investing in not dividend paying companies to invest in us. So I guess we try -- although our dividend is relatively modest, by pure standards we sort of look at the 20 to 22% of prior year earnings, 1% plus dividend yield, and try to maintain it at that, to at least enhance the quality of the investment as much as we can.

Great. Thanks a lot, Gerry.

Yes, you bet.

Your next question comes from [Eric Rubelik].

Hi, good morning.

Hi, Eric.

I think everything was answered except one question, and maybe Mike can -- or you, Gerry, for that matter. The business that you're doing in Lansing and Ann Arbor, whether it's the amount that's already been booked or the loans that are in pipeline, is the nature of the customer or the nature of the type of loan materially different than what you're doing in west Michigan?

Not materially different. Clearly from an asset standard, asset quality standard what we're looking for in the quality of cash flows and management and collateral, it's exactly the same. We have a compromise there. From a market segmentation as does it look different from what these customers do, I would say with the exception of in Ann Arbor there's a little bit more driven, as you might imagine, from the university, than we have in any of the other markets we are in. But other than that it looks real similar, very strong customers who they get involved in everything from manufacturing to -- we've got some wholesaling going on and some other -- some commercial real estate going on. So doesn't look significantly different with maybe a slight little slice of Ann Arbor with some university related business.

Eric, this is Gerry. Just a couple of numbers for to you back up what Mike said. If you look at RSMA here in west Michigan, manufacturing employs roughly 22% of those who are employed. In Lansing, that drops to 9%, and in Ann Arbor it's 11%. So I think what you will see from an industry segmentation is fewer industry or manufacturing related loans and more related to education or government or service. Especially in Ann Arbor. So one of the nice things about that is it really helps diversify our portfolio more strongly across additional economic and industrial lines.

Yes. Okay. Thank you very much.

Thanks, Eric.

[OPERATOR INSTRUCTIONS] You do have a question from [Dan Quirk].

Good morning, guys. Great quarter. I just wanted to ask a little more questions on the capital issue. At what point can we expect an ROE say north of 15, 16% to the point where you guys can self-fund asset growth? I view a capital raise, as a shareholder, the same as an earnings charge.

Well, a couple of us can answer that question. I think at this point if we stop growing the organization we could have an ROE north of 15%. I won't say immediately, but pretty quickly. But I think as we look at our investor base, 40 to 45% of that is institutional. Of those institutional investors, well over half have invested in our company because of growth, not because of our ROE. We tend to focus more on our growth in earnings per share than we do on our ROE. And if you look at our ROA, it actually is becoming pretty respectable, but because of our level of capital, obviously, if this is what you're referring to, our equity multiplier is low, and that, mathematically, is going to keep ROE from increasing significantly. But as we mentioned in our presentations, if we grew at the rate of our peer group, 7 to 8% a year, we'd have an ROA somewhere in excess of 120 basis points, an ROE of 15 to 16%. I guess we're not ready to give up the opportunities for growth at this point.

When we go out on the road to raise capital the people that tend to invest in our company are aware of that. They're aware of the near-term EPS dilution. I'm a major shareholder, and so I'm very sensitive to it. But I think if you take a look at our earnings, at our capital raises. We mitigate those additional -- the increases in those shares in a pretty short period of time because of the growth. If we were just -- if we were short of capital and took a look out and said, an equity raise doesn't make sense we need capital, that's when you look at something like a trust preferred or sub debt or something like that. I don't know, Chuck, if you had any--?

Nope, I think that's it.

I just wanted to add on, I agree obviously with what Gerry is saying. It's a matter of focus on where we want to be. I can remember a couple years ago someone asking us when we were around 9 or 10% ROE, when are you going to get to 11 or 12? And we could have easily done it. Just like Gerry said, slow down the growth and gotten there. Now that we're in the 11 or 12 market, the next area, the question is when are we going to get to 15, 16. Again, we could slow down the growth, but if we had done that a couple years ago we wouldn't be the second largest bank in Kent County. We wouldn't be almost $2 billion, and we wouldn't have 20% earnings growth just about year-over-year. So I think we're trying to balance everything in the right interest of the shareholder, and it just gives us maybe a little slower ROE increase than maybe some people would like to see, but if you look at all the rest of the metrics we think that it's a great position to take.

Okay. Thank you very much.

Thanks.

There are no further questions at this time.

Well, at this point we'll conclude the teleconference. Thank you all for not only attending, but for your questions. Have a good day.

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