Mercantile Bank Corp (MBWM) 2006 Q1 法說會逐字稿

Welcome to the Mercantile Bank Corporation first-quarter earnings conference call.

There will be a question-and-answer period at the end of the presentation. (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 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 for Mercantile Bank Corporation we have Jerry Johnson, Chairman and Chief Executive Officer, Mike Price, President and Chief Operating Officer, Bob Kaminski, Executive Vice President, and [Darren Gantz], Vice President of Accounting. We will begin the call 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. Please go ahead, sir.

Thank you. Good morning and thank you all for joining us this morning. As we speak, Chuck Christmas and his wife are in China adopting a new daughter, so Chuck is not with us this morning, and I would like to welcome Darren Gantz, our accounting manager, to the conference.

If you have additional questions after the teleconference is over, if we don't answer them to your satisfaction as we are speaking, please feel free to call Darren or me and we will do our best to respond. I would also mention, Chuck will be back in the office this coming Monday.

The banking industry is, I think as you all know, is operating in a tough environment today with the interest rate scenario and whatever. As a result of that, we are extremely pleased to announce another quarter of outstanding earnings performance. As you may know, we also have declared a 5% stock dividend and the $0.13 per share quarterly cash dividend, both payable in the second quarter. I would note that the $0.13 dividend is a $0.01 per share increase over the dividend that we paid this current quarter. After giving effect to the 5% stock dividend paid in August of 2005 and the 5% stock dividend that we will pay this May 16, our cash dividend paid in the second quarter of this year is 30% more than the dividend that we paid in the second quarter of last year.

Regarding our earnings per share performance, although 13% increase in earnings per share is a little below what we have historically reported, I think our performance is especially significant because, at this time last year, we had not moved into our new building, nor had we moved into the Lansing and Ann Arbor markets, and thus, we had none of these expenses in our P&L last year. So I think a 13% increase in earnings per share is a pretty outstanding accomplishment.

Additionally, while many financial institutions experienced volatility in their interest rate margins in 2005, we maintained our margin within a band ranging from 3.46 to 3.54, or 8 basis points. As many of you know, our stated goal with regard to interest rate risk management is not to earn the last ultimate basis point in yield, but to keep our margin as high as possible but within a fairly narrow band, and this we accomplished again.

I think another factor assisting us in achieving our outstanding earnings performance was management's decision not to accrue bonus dollars during the first quarter. Not only did this decision boost our earnings, I think it also sends a very clear message to our investors that their interest precede those of management of the Company.

Also contributing to our earnings performance was our continued strong asset growth. Assets increased 232 million or almost 14% over the first quarter of 2005. Earning assets were up 225 million or 14.3%. Our asset growth, combined with our excellent management of our interest rate margin, resulted in an increase in spread income of over 19% during the period. Increased net interest income, coupled with good cost control, resulted in an efficiency ratio below 50% for the quarter.

My last comments pertain to asset quality, which both Mike and Bob will also discuss. Although charge-offs and nonperforming assets increased slightly during the quarter, both remain at the lower end of our peer group and we're making good progress at working through several problem credits that former loan officers put on our books. I would also emphasize, as I have previously discussed with many of you, that Mercantile has a very low exposure to the automobile industry and therefore has no significant vulnerability to that manufacturing sector.

With that, I will turn the proceedings over to Darren.

Thank you, Jerry.

I'm going to present an overview of our financial condition and operating results for the first quarter of 2006. I will highlight major financial condition and performance, balances and ratios.

Our net income equaled 4.93 million in the first quarter of 2006, an increase of 0.6 million or 13% (indiscernible) the 4.36 million earned in the first quarter of 2005. Our diluted earnings per share equaled $0.64 in the third quarter, an increase of 12% over the $0.57 earned in the third quarter of 2005.

Increases in our net income continue to be achieved due to strong growth in net interest income resulting from earning asset growth and an improved net interest margin, which has more than offset the initial expansion costs associated with our expansion into the Lansing and Ann Arbor markets in mid 2005.

Our net interest income equaled 15.1 million in the first quarter of 2006, an increase of 2.4 million or 19% over the 12.7 million earned in the first quarter of 2005.

Our average earning assets equaled 1.78 billion in the first quarter of 2006, an increase of 267 million or 18% over the $1.5 billion average in the first quarter of 2005. Our average loans equaled 1.58 billion in the first quarter of 2006, an increase of 236 million over the level in the first quarter of 2005. It also represented 88% of the increase in overall averaging assets, quarter-over-quarter.

Our net interest margin equaled 3.51% in the first quarter of 2006 (inaudible) 5 basis points or 1% over the 3.46 margin achieved in the [third] quarter of 2005. Improvement in the net interest margin primarily reflects the increases in the prime rate, increases in loan interest income more than offsetting the increased deposit and borrowing costs.

As in the past, the main issues impacting our net interest margin include loan yields, federal reserve actions, and wholesale fund rates. Our variable rate loan portfolio has declined as a percent of total loans over the past several quarters. As of March 31, 2005, 78% of our total loans (indiscernible) variable-rate loans. As of December 31, 2005, the percentage was 73%. As of March 31, 2006, variable-rate loans consisted of 68% of our total loans. (indiscernible) is primarily due to new borrowers taking the fixed-rate option.

While 35% or 375 million of our floating rate portfolio consists of loans with [rate] ceilings, the prime rate increase on March 28 -- 200 million or 19% of total floating-rate loans did not increase. (technical difficulty) -- the prime rate continues to increase, about $40 million per rate increase (inaudible) ceiling.

The cost of our wholesale funds has increased and will continue to do so as maturing funds are replaced with funds at higher rates. For the second quarter of 2006, approximately $235 million (inaudible) funds will mature at a weighted average cost of 3.90%. In the last six months of 2006, approximately $365 million of wholesale funds will mature at a weighted average cost of [4.15]%.

Currently, our 12-month CD rate is at 5.15%, which reflects the market pricing and future (inaudible) increase.

Our loan loss provision expense was $1.2 million in the first quarter of 2006, an increase of 0.5 million or 69% over the 0.7 million expense in the third quarter of 2005. The lower coverage ratio and similar loan growth were more than offset by a higher level of net charge-offs in the (inaudible) loan.

Our net interest income increased slightly in the first quarter of 2006, up about $40,000 (inaudible).

Noninterest expenses equaled 8.0 million in the first quarter of 2006, an increase of 1.2 million or 17% over the $6.8 million expensed in the first quarter of 2005.

Our efficiency ratio climbed from 39.4% in the first quarter of 2005 to 49.0% in the first quarter of 2006. But the $1.2 million increase in overhead costs, 3.6 million or 52% were salaries and benefits. Our full-time equivalent employees increased from 212 as of March 31, 2005 to 275 at March 30, 2006, a 30% increase.

Occupancy and equipment costs were up $0.5 million, which represented 40% of growth in total overhead costs. The increase was related to the opening of our headquarters building in Grand Rapids, (inaudible) Lansing and Ann Arbor offices. Although overhead costs increased $1.2 million, net interest income during the same period increased $2.4 million.

I've also noticed that our noninterest expense has decreased by about $800,000 in the third quarter, as compared to the fourth quarter of 2005. The decrease results from a reduction in our bonus accrual\ in the first quarter of 2006 and from the $300,000 in expenses taken in the fourth quarter with regards to the closing of our division office in Grand Rapids.

As far as asset growth, average assets of 1.87 billion in the first quarter of 2006 increased to 280 million, 18%, or 1.5 times (indiscernible) dollar average in the first quarter of 2005. Average loans equaled 4.58 billion in the first quarter of 2006, an increase of 236 million or 18%, in comparison (inaudible) $1.35 million average (inaudible) 2005. Overall, there have been no major changes in our asset composition.

As far as our funding, our strategies have not changed. We continue to try to grow local deposits to bridge the funding gap with wholesale funds, including broker CDs, FHLB advances. Local deposits and repurchase agreements were up 60 million or 11% since (indiscernible) 2005. Wholesale funds, on the other hand, were down 1.8 million since (inaudible) in 2005, which is a positive trend.

The ratio of average wholesale funds to average total funds has remained stable. For the first quarter of 2005, the average was 67%; fourth quarter of 2005, the average was 68%. The average in the first quarter of 2006 was 67%.

As far as our capital position, we remain in a well-capitalized position for bank regulatory definitions. Our total risk-based capital ratio equaled 11.91% as of March 31, 2006.

That's the end of my prepared remarks. I will be happy to answer any questions in the question-and-answer session. Now, I'm going to turn it over to Mike Price.

Thanks, Darren. Good morning, everyone.

Three major items that I think standout in today's earnings release are, one, the continuation of our outstanding earnings growth once again; the continuation of our strong asset growth, which has been a hallmark of Mercantile since the day we opened the doors. Of that strong asset growth, our two regions contributed 32% of our net loan growth, 28% of our net deposit growth. So, we're very excited about the continuing progress there. The third issue that stands out is an increase in our nonperforming loans.

Since Jerry and Darren have both commented on the earnings growth, I will only add my emphasis to the significance of the 12% earnings growth over last year's first quarter, during a time we significantly build the bank's balance sheet and expanded our market footprint. Once again, we enjoyed strong asset growth as total assets grew by over $58 million during the quarter with loan growth accounting for a little over $50 million of this increase. As I mentioned before, our new Lansing and Ann Arbor locations were large contributors to this growth. We are very happy with both locations, as Lansing now exceeds $33 million in assets and Ann Arbor closed the quarter at almost $17 million in assets.

In regards to our nonperformers, while our nonperformers and charge-off numbers continue to be very strong, as you all know, we have very high standards here at Mercantile, so we were slightly disappointed in the increase in our nonperformers at quarter end. While most all these loans were very well-secured, many of them are secured with commercial real estate that are going through the normal collections process. We did identify one situation that is unusual, and I will have Bob Kaminski address that situation in his comments.

As always, I will also be happy to answer any questions at the end of our prepared comments. And at this point, I think I will turn it over to Bob Kaminski.

Thanks, Mike. I want to spend a few moments this morning discussing the loan situation mentioned in our press release. I must preface this with a statement that comments about the situation should be limited, due to the facts -- due to the fact that the details of the situation continue to unfold and that legal action is currently in process.

During the quarter, Mercantile identified 11 loans related through a common source of origination totaling approximately $2.6 million. The purpose of these loans that have been to the Bank in the application process was to finance the purchase of vacant residential real estate lots on which new homes would be constructed by the individual borrowers. Investigation by bank loan review personnel has discovered that the purpose, collateral and structure of the loans do not appear to coincide with what was portrayed to the Bank in the application process. These loans have been placed on nonaccrual. The Bank is currently pursuing various legal remedies against the multiple parties to these transactions and expects real estate collateral it received in connection with the loans to eventually be liquidated as part of the collection process. While it is early in the litigation and evaluation process, management has allocated a portion of the allowance for loan losses to these specific credits, based on their current assessment of the value of the collateral and the other collection avenues currently being pursued.

I will now turn it back over to Jerry.

Thanks, Bob. With that, we would be happy to take any questions you might have.

(OPERATOR INSTRUCTIONS). John Rowan, Sidoti & Company.

Good morning, everyone. Jerry, can you just go over the thought process behind not accruing any management bonuses in the first quarter and what we can expect going forward?

Well, John, the way our bonus plan is set up, we don't begin accruing bonus dollars until the increase in earnings hits 15%. That's our threshold. So, it really was a mathematical decision. We have, in prior quarters, done the same thing, and this is a tough quarter when you're comparing this quarter with a year ago, as I mentioned in my remarks. We didn't have any of the Lansing, Ann Arbor or new billing expenses. Once we get to the third and fourth quarters, we're going to be comparing like quarters, and we would hope that you would see stronger -- although I don't think 13% isn't strong -- but it will be a little easier to identify the expenses and look at bonus allocations. So our bonus plan -- the non-lender bonus basically is a minimum of 15% increase in earnings during the period, before you start accruing, and for full bonus payout, earnings have to be up 15%, including the bonus accrual. So it's a very aggressive bonus. Again, we think this should send a good message to our shareholders. We don't pay bonuses for increasing earnings growth by 2, 3, 4, 5%. It's got to be significant.

Very good. Just a question on the loans that were charged off in the quarter -- were any of those related to the fraudulent loans that were reported?

No.

No, okay. I know that you went over the quarterly CD maturations, but I didn't quite catch it. Can you give me the second, third and the fourth-quarter numbers again?

Yes. Wholesale funds maturing in the second quarter of 2006 were 235 million at a weighted average cost of 3.90%. Then the last six months of 2006, 365 million will be maturing at a weighted average cost of 4.15%.

Thank you, those are all my questions. Thank you very much.

Kevin Reevey, Ryan Beck.

Good morning. Congratulations on a great quarter.

As a result of what happened with those loans that you are in the process of litigating, has this resulted in any changes to your underwriting policies or credit authority?

Yes, Mike Price. We did a thorough review of what happened in this particular case. I think it's important to note, by the way, that our loan review team caught this very early in the process. There appears to be other banks possibly involved in this. We were the first one to the table, for what that's worth, as far as identifying it and getting it at least underway as far as resolution goes. There's also been changes to individual loan authorities because of that; there's also been changes to the loan policy because of it. So, all of those things made us take a more conservative view of certain areas of our procedures and policies.

Then my last question is I noticed that your service charge line item declined roughly about 8% linked-quarter. I was just curious. Is that seasonal or is there something else going on in that line item?

Actually, we've taken a look at that to be able to give you a good answer. I can have Darren come get back with you on that and we could do some further analysis of it.

Okay, great. Thanks.

[Howard Ridley], Security Financial.

Good quarter, guys. Unfortunately, you finally got caught in a bad loan, but that's the banking business.

That happens, and no, it's not -- it -- compared to our size, it's not a huge situation but it's certainly an irritant -- (multiple speakers).

Well, (indiscernible) but there are dishonest people out there and there's not much you can do about that.

My question is quite simply, at this point in time, what is your best guess or what would you project for the Bank and how much more can it grow its assets without having to go back out in the capital markets?

At our current rates of growth, we probably can get through much of next year before we need to go back to the capital markets.

Okay, thank you. Also, I think the increase in the dividend consistently and the 5% stock dividend is a good strategy move for the investors.

Well, I appreciate that. We do it for those reasons and it's good to hear good, positive feedback on that, so I appreciate it.

Thanks a lot, Jerry.

Eric Grubelich, KBW.

We were having a little trouble hearing Darren roll through some of the numbers for the quarter. Speaking of which, on the expense side, did you mentioned that there was a $300,000 sort of excess expense in the last quarter related to overhead that you didn't have this quarter?

Yes, it was a one-time expense related to the closing of our division office in Grand Rapids as we made the move to our Leonard headquarters building. It was about $300,000 taken in the fourth quarter.

In the fourth quarter, okay, good. The other question for Jerry was related to that problem credit. Jerry, at the beginning of your prepared remarks, you made mention that these problem -- and I assume your comment was with regard to this 11 individual loans. You made a comment regarding former loan officers. Did I understand that correctly?

Pretty much.

Okay, so those people that made this group of loans, they are gone?

I will let Mike --

It's a very complicated situation. There were many people involved in the situation, and actually we're not at liberty to discuss that at this point, given some confidentiality agreements that are out there. Actually, Jerry was talking about some loans that were charged off in the previous quarter, and that doesn't involve this particular situation.

Yes, I didn't understand that, Eric, yes but --.

Okay, so it's other loan losses in the quarter, the other ones that were not -- I guess you didn't have any charge-off on this credit if I understood your comments.

That is correct.

That is correct.

Okay, that's fine. Then the only other question I had for you was, with regard to new markets, has there been any change there with your expectation on finding other areas besides Lansing and Ann Arbor?

Eric, we're looking at a number of them, but you're not going to see anything this year. We are extremely pleased with Lansing and Ann Arbor, but we really want to have those two areas generating not only the growth that they are generating but good profitability. I think it would be premature for us to go into yet another market this year. So I would say the earliest you would see us looking at other markets seriously would be probably mid-2007.

Okay, so that hasn't changed from last quarter then?

No, no.

Okay, great. Thanks very much.

Christopher Nolan, Oppenheimer.

If I understand correctly, the comments on the bonus accrual -- if you don't hit 15% annual EPS growth in the second quarter, then that $500,000 bonus accrual expense does not occur. Is that correct?

That is correct.

So that would require basically a second-quarter EPS of approximately $0.70 to achieve that?

That's probably about right.

Okay, so if you -- if we believe -- if one were to assume that EPS were coming south of -- below $0.70, then we can basically take off $0.5 million off the operational expenses. Is that correct?

Yes, I don't think you really need to do a lot with your models that all. I think it's just, if you look at your model and it's not a 15% growth in earnings, there will not be a bonus accrual in there; that is correct.

Okay, great. Can you give some comments about how the overall economy is heading out there and how the overall credit quality situation is developing in the -- for not only Mercantile but for the overall competitive environment?

Yes, this is Mike. It certainly continues to be an interesting market out there, and the global standpoint I think we've all heard about how well the USA economy is doing, and that certainly is true. But there are certain stubborn areas in the Midwest, particularly in Michigan and Indiana, that are still struggling. We are still seeing that and we've had, as you can tell in our numbers, Mercantile has had an incredible history of very, very low numbers of charge-offs in nonperformers. Those have picked up a little bit because I think some of the troubles that we've seen in the local economy have settled down into particular credits here. I would say, going forward, we don't see it getting any worse. If it's trending anywhere, it's probably trending to be a little bit better. But again, the overwhelming majority of our particular portfolio continues to do extremely well.

Are you still seeing -- final question -- are you still seeing a lot of loan, basically some of the larger players come in and going down market to smaller and smaller (indiscernible)? Is that phenomenon still happening?

Yes, I mean the whole market is being very, very competitive. Somebody must have published something years ago that said every bank in the world needs to be in Grand Rapids. I mean, we're just seeing a lot of competition. We have, though, since the day we opened the Bank. I think what we're seeing most is just, because it's so competitive, we're seeing some banks being extremely cheap on rate and extremely loose on credit enhancements and guarantees and collateral. That is just an area we try to avoid. We certainly don't want to go down that road where we loosen our credit standards at all. So that's the biggest dynamic we see in that area.

Great, thank you.

(OPERATOR INSTRUCTIONS). Brad Vander Ploeg, Raymond James.

Good morning, guys. Good quarter. Most of my questions have been asked; just one quick follow-up -- I want to make sure that I understand on the expense side that the new location expenses are pretty much a thing of the past. In other words, the first quarter wasn't a wall and you'll have maybe a little bit more that will kick in the second quarter or later on.

This is Mike, Brad. That would be a correct assumption. One of the things you can look at in her consolidated financial highlights that will give you a good indication from that is the full-time equivalent employees only went up by two in the first quarter. If you go back and look at the last five quarters, you'll see -- you know we had a big spike, as Jerry alluded to, during the second, third and fourth quarters of last year. So the people are in place and certainly the leases and all of that are in place.

The next major -- or I should say the next significant increase in costs will be sometime in 2007 in Lansing when we get to the permanent building. But that's a ways away yet.

Okay, good. Then also, Jerry, would it be safe to say -- I think, at the very beginning of your comments, you mentioned the difficult interest-rate environment. It sounds like that's the main challenge out of everything going on, whether it be loan growth or asset quality or anything -- (multiple speakers).

I would say that's true for the whole industry, Brad. It really is. You know, fortunately we are not as you would say upside down in the thing. We anticipated the increases in rates and we are pretty well set up for it. Through our wholesale funding, we've we can really manage the average maturities of our wholesale portfolio. Again, our goal, as I mentioned in my comment, is not to get the -- we could put another 30, 35 basis points onto our margin immediately if we wanted to, or in fairly short order, but our goal really is to keep it as strong as possible but in a pretty narrow band. As I mentioned, we've been within about 8 basis points or so for the past 12 months. That's really the goal, is just to make it a little bit more predictable.

Okay, very good. Thanks very much.

Brad Ness, Friedman, Billings, Ramsey.

A quick question -- I didn't catch all of those figures regarding the rate ceilings on some of your loan products. I was wondering if you could just have Darren comment on those again.

Sure. As far as variable-rate loans, about 35% or 375 million of our floating-rate portfolio consists of loans with rate ceilings. When the prime rate increased on March 28, about 200 million or 19% of the total floating-rate loans did not increase. If the prime rate continues to increase, about $40 million per rate increase will hit ceilings.

Great, thank you.

(OPERATOR INSTRUCTIONS). Michael [Sokopf], Lycos Capital.

Actually, my question has been answered. Thanks, guys. Great quarter.

There are no further questions at this time.

Well, as always, we appreciate your interest in our company. Thank you for attending, and this concludes the teleconference. Thank you all.

This concludes today's teleconference. You made now disconnect.