Mercantile Bank Corp (MBWM) 2006 Q2 法說會逐字稿

Welcome to the Mercantile Bank Corporation second quarter earnings conference call. There will be a question-and-answer period at the end of the presentation. (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 website at 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, Senior Vice President and Chief Financial Officer; and Bob Kaminski, Executive Vice President. 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.

Thank you, Claudia. Thank you all for joining us this morning. Although the first six months of 2006 have been challenging, I believe that the management and staff of Mercantile Bank Corporation have demonstrated their ability to continue to produce superior operating results.

The challenges have come primarily in four areas. First, effecting a meaningful increase in current period earnings per share over the first six months of 2005, notwithstanding the fact that the majority of our expansion costs into Lansing and Ann Arbor were not incurred until the second half of the year, and our move into our new corporate headquarters did not begin to impact overhead expenses until May 2005. These timing differences make comparing the first six months of 2006 with the first six months of 2005 difficult, to say the least.

Second, ongoing margin pressures brought about by the volatility in short-term interest rates due to Fed actions and market anticipation of Fed actions, as well as the industrywide trend in the disintermediation of savings and money market deposits into higher costing CDs.

Third, growing our balance sheet in an environment that is increasingly competitive as we continue to gain market share at the expense of our competitors, who have shown a renewed and aggressive willingness to undercut Mercantile's pricing on new deals, oftentimes to absurdly low levels, unreflective of the proposed transaction's credit risk.

Fourth, maintaining our historical and traditional asset quality numbers has also been a challenge, but our numbers have remained consistent for two quarters, and the slight increase in nonperformance since December of 2005 is, in our view, a short-term situation and not an indication of a secular trend.

I believe we have dealt very effectively with these challenges. First, diluted earnings per share increased 10.7% over the first six months of 2005, which Chuck will discuss further in a moment. Our year-to-date margin at 3.49% is unchanged from the prior year, and Chuck will also discuss this. Loan growth for the first six months of 2006 is $246 million, an increase of 17.2%, and asset growth is $260 million, an increase of 15.2% over the prior year period.

Helping us to fund this growth has been an excellent increase in local deposits, and Mike and Chuck will both have further comments regarding our loan and deposit growth.

Four, with regard to nonperforming assets and charge-offs, although our ratios remain well within peer group parameters, we continue to work diligently to bring these numbers back to the historically low levels reflected in last year's performance. To that end, we have made strategic changes in our lending staff through attrition and additions to our lending officers. Michael will further expand on our very positive staff additions.

I believe, in summary, that we have dealt and are dealing very efficiently and effectively with the numerous challenges that we are facing in 2006, and we remain very optimistic about the balance of the year. With that, I will turn the conference call over to Chuck Christmas.

Thanks, Gerry, and good morning, everybody. What I would like to do, as I have done in the past, is provide you an overview of Mercantile's financial condition and operating results for the second quarter of 2006, as well as the first six months of 2006, highlighting the major financial condition and performance, balances and ratios.

Our net income for the second quarter of 2006 was $5.1 million, or about 9% over what we earned in the second quarter of last year, and for the first six months of 2006 we earned $10 million, which is about an 11% increase over what we earned in the first six months of 2005.

On a diluted earnings per share basis, the second quarter of 2006 came in at $0.63, an increase of 9% over the $0.58 of the quarter of 2005, and on a year-to-date basis we have earned $1.24, an increase of 11% over the $1.12 we earned in the first six months of 2005.

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

Our overall profitability is driven by continued strong earning asset growth, which is translated into increase net interest income, further supported by a steady net interest margin. During the second quarter of 2006 our net interest income totaled $15.6 million. That is an increase of $2 million, or 15% over what we earned in the second quarter of last year and on a year-to-date basis our net interest income totals $30.7 million. That is an increase of almost $4.5 million, or 17% over the first six months of 2005.

Our average earning assets during the second quarter of 2006 totaled $1.84 billion. That is an increase of about 16% over average earning assets in the second quarter of 2005.

As always, our loan portfolio continues to lead our balance sheet, structure, and growth. During the second quarter of 2006 our average loans equaled $1.64 billion, an increase of $241 million over the second quarter average of last year. That is about 93% of our average earning asset growth, again is with the loan portfolio.

Our net interest margin during the second quarter 2006 was 3.47%, down slightly from the 3.52% of the second quarter of last year, but as Gerry already mentioned, for the first six months of this year our net interest margin was 3.49%, unchanged from the first six months of last year. As is always our goal, we try to maintain a steady net interest margin, and we have been able to achieve that over the last five quarters, with our net interest margin ranging only 8 basis points.

As we look forward to our net interest margin, again we don't provide any specific guidance, but as in the past, the main issues continue to be our loan yields, certainly the Federal Reserve, and wholesale funding rates.

At June 30, 2006, approximately 64% of our loans are variable rates. That is down from 73% at the beginning of the year and down from 75% of total loans a year ago. The decline is primarily due to our borrowers taking fixed rate options over the floating rate options over the last 12 months. About one-third of our loans -- excuse me, about one-third of our floating rate loans have ceilings. In the last prime increase of a couple weeks ago, $255 million, or about 24% of our floating loans did not increase due to rate ceilings. The next rate increase, if there is one, an additional $20 million will not increase. However, as you can see, a majority of our floating rate loans have now reached their ceilings.

An interesting note is that if rates do start to fall, as many predict in 2007 and beyond, it is interesting to note that these loans that are at their ceilings will actually act as fixed rate loans for at least some period of time.

Our cost of wholesale funds have increased and will continue to do so as maturing funds are replaced with funds at higher rates. For the remainder of 2006, we have about $430 million set to mature and an overall cost or average cost of 4.3% that compares to a twelve-month CD rate currently of 5.6%.

Our loan loss provision expense for the second quarter of this year was $1.5 million, an increase of about $600,000 over the $900,000 we expensed in the second quarter of last year. On a year-to-date basis our provision expense totals $2.7 million, $1.1 million increase of what we expensed in the first six months of last year.

A lower loss reserve coverage ratio and a similar loan growth have been more than offset with a higher level of net charge-offs. Our fee income, or non-interest income, in the second quarter of 2006 totaled $1.3 million, up 5% from the second quarter of last year, and on a year-to-date basis our fee income totals $2.5 million, up about 4% from the first six months of last year.

A slight decline in service charges on deposit accounts, primarily reflecting increased in earnings credit rates on our demand deposits, are being offset with increases in virtually all other fee income categories.

Moving on to overhead costs, reflective of initial expansion cost primarily incurred in mid to late 2005, overhead costs were up significantly when comparing the first six months of 2006 with the first six months of 2005, but the growth in overhead costs has now slowed dramatically, as you leverage the staff and facilities increases experienced during 2005.

In the second quarter of this year, overhead costs totaled $8 million, an increase of about 12% over the second quarter of last year, and on a year-to-date basis, overhead costs totaled $16 million, about a 15% increase over the first six months of last year.

Of the $2 million increase year-over-year, approximately 45% is in salaries and benefits, brought about primarily due to increased staff with FTs increasing about 17% during the last 12 months. This was offset partially by a lower bonus accrual during 2006 compared to 2005.

Our occupancy and equipment costs are also up about $0.9 million which equates to about 45% of the growth in total overhead cost, and that is reflective primarily of opening of our Grand Rapids headquarters as well as our Lansing and Ann Arbor offices.

As of June 30, 2006, our assets totaled $1.97 billion. That is an increase in the second quarter of $72 million, with our loans up about $58 million. In the last 12 months, assets have increased $260 million with loans being up $246 million, or 17%. Again, there are no major changes in our asset composition.

Our funding strategy has not changed significantly, as we continue to grow local deposits and bridge the funding gap with wholesale funds, that being broker CDs and federal home loan bank advances. As Gerry already mentioned, we have had very strong deposit growth locally in the first six months of 2006. Our local deposits and repurchase agreements are up almost $90 million on an annualized basis. That equates to 40%. Our wholesale funds are up about $40 million, or 8% on the annualized basis.

Our average wholesale funds to total funds in the second quarter of this year totaled 65%, down from the 66% level in the first quarter of this year and down from 69% during the second quarter of last year. With regard to capital, Mercantile remains in a well capitalized position, with a total risk-based capital ratio of 11.7%, as of June 30, 2006. That's my prepared remarks. I would be happy to answer any questions in the Q&A session. I'll turn it over to Mike.

Thanks, Chuck. Good morning, everyone. As you have already heard, the second quarter was another quarter of good growth in both loans and deposits for Mercantile Bank of Michigan. It also was a quarter we spent significant resources on asset quality improvements.

While our charge-offs and asset quality numbers are virtually unchanged from the first quarter compare favorably to most banks throughout the country, our management team continues to work diligently to bring these numbers more in line to the top tier performance Mercantile has become known for throughout its nine-year history.

Many of our nonperforming loans are nearing resolutions, and the rate of new additions to this category appears to be slowing. We improved our asset quality infrastructure by aggressively identifying some loans that showed early signs of weakness during the quarter and placed work-out plans in place to either move the loans out of the bank or collect then off the books. We have also further strengthened our policies and procedures, as well as our documentation expertise within our less experienced employees.

During the last quarter we also improved our credit culture by making strategic changes in our lending and credit staff. The most noteworthy addition was of Thomas Fitzgerald, who was hired as our credit administrator. Tom has an outstanding and long track record as a strong credit administrator and should be a great addition to our team.

Finally, our approximately $2.6 million nonperforming loan involving real estate on the eastern side of Michigan continues to wind its way through the legal system. We have seen a slight decline in the loan balances of this particular situation due to some customers rewriting their loans with us into acceptable quality loans.

Finally, I should also comment on the excellent opportunities we continue to see across our franchise. All of our markets, including Lansing and Ann Arbor, are experiencing nice growth in deposits and loans. As always, I will be glad to answer any questions at the end of our prepared remarks, but at this time I'll turn it over to Bob Kaminski.

Thank you, Mike. My comments this morning will focus on some product and operations updates. In 2006, Mercantile has launched some initiatives and continued some others to enhance deposit growth.

Mercantile has developed what we call our Executive Banking Package, a new product geared toward the personal banking needs of our business owners and operators. This package consists of several customized products and services allowing the customer to complete all of his or her personal banking with Mercantile as they do their business banking.

Secondly, Mercantile was one of the first West Michigan banks to offer health savings accounts to new and existing customers. This has been a nice addition to our product arsenal when looking to make inroads with new business prospects. We have seen good growth in monthly account openings of this product.

Third, Mercantile has developed some very nice deposit relationships with local municipalities in the first half of 2006, and this has provided a good enhancement to our local deposit growth.

Operationally, Mercantile remains on track for a fourth quarter rollout of our next generation Internet banking product. Coupled with our other electronic banking capabilities, this will allow Mercantile customers, either business cash management or personal banking, to continue with a first-class method for managing their finances online.

Finally, I wanted to comment that Mercantile is in the process of acquiring two parcels of land across the street from our Leonard Street main office facility for future growth of our organization in the Grand Rapids market. Mercantile has been working with the City of Grand Rapids for plans to allow for a multi-story facility that would compliment the existing main office and allow for continued growth in support of lending, deposit gathering, and business development functions. There are no immediate plans for starting of this project, however, as the actual need for this space is likely still a few years away. But this gives the bank the capability and capacity to continue to accommodate its ongoing plans for growth in Camden County. Those are my prepared comments. I will now turn it back over to Gerry.

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

(OPERATOR INSTRUCTIONS). Christopher Nolan of Oppenheimer Company.

Quickly, when you are discussing the NPAs that are near resolution, should we view that as there could possibly be an improvement in the third quarter on the volume of NPAs on the balance sheet?

This is Mike. I think when -- especially when we look at our NPAs, a large number of them involve commercial real estate which, I am sure you know, it takes some time to wind their way through, in some cases, foreclosure and in sale and that kind of thing. So I would say I think what -- it especially bodes well for in the third quarter is getting some of them off the books or moving them back into either performing or totally off the books, but certainly for the fourth quarter, it looks even better.

So when you say off the books, this could be like a sale of nonperforming loans?

Yes. Sale of the property, disposition of it. At this point we don't -- we never know exactly, outside of appraisals and market conditions, what we're going to see on those sales, but we think in most cases we have charged them down, where necessary, to appropriate levels so that there wouldn't be a lot of additional loss with them.

Great. And Chuck, in the first quarter, the nonaccrual, the lack of management accruals is about, as I recall, $500,000. Could you give me a number for what they would've been in the second quarter?

You are talking about what we would have accrued normally --

Yes, please.

We would have accrued for the first six months approximately $1.4 million. That's for the first six months.

Great. And what was the percentage of loans that are variable right now?

About a third of our portfolio.

Great. I know you mentioned that $430 million of CDs are set to mature in the second half of 2006?

That's correct.

Great. And was the average rate on that 3.9%?

4.3%.

4.3%. And finally what was the volume of CDs that matured in 2Q?

I don't have that right with me, Chris.

Great. Okay. Thank you very much.

Kevin Reevey with Ryan Beck.

Chuck, could you give us a breakout of your loan growth by category?

I don't have the specific information in front of me, Kevin, but it's pretty consistent with what we have seen in the past and, obviously, we continue to be about 92% commercial. We haven't seen any significant changes with regards to that percentage or as well as the breakdown within the commercial portfolio, whether it be construction development or typical real estate or C.I. lending. So there's nothing major there. The only difference that we have been seeing, as I mentioned, is just a more preponderance of taking a fixed-rate option over a floating rate option.

And then can you talk a little in more detail about the strategic attrition on the credit side?

Kevin, this is Mike. I think what happens from time to time, we continually look through our lending staff and our credit staff to make sure that the people we have on the team line up, from a credit quality and some of the other issues that we have, with the goals and very high expectations at Mercantile. At second quarter especially, we had some people who left the Bank that I think strategically strengthened our credit culture.

But I think as we made mention in our remarks, we are more positive about the gains that we made, and especially with Tom Fitzgerald coming out as our credit administrator. We think that's an even bigger part of the story, when we look at the pluses and minuses of staff changes during the quarter.

Great. Thanks.

Brad Vander Ploeg with Raymond James.

The margin still has held in extremely well, given the difficult interest rate situation. I am just curious with the, you know, potential for maybe one more rate hike here, how you plan to navigate that, and then, of course, hopefully some of that pressure will be relieved later in the year and going into 2007, but is that something that we should be concerned about at this point?

This is Chuck. You know, like we have been mentioning, the increase that we saw in our margin over the last couple of years, a large part of that is just more of timing difference, with the vast majority of our assets being tied to prime and a big majority of our liabilities being fixed-rate. So we do have that lag effect, which we benefited when rates are going up in the front end, and then everything kind of catches itself up.

One of the things we've been trying to do since rates started going up is still staying relatively long on the CD portfolio. Once we see, and it is much more clearer than it is today, that we are at the end of the Fed increases, we will start declining that duration on our CD portfolio, our broker CD portfolio, pretty aggressively which will help offset that lag effect on those fixed-rate CDs still coming at us.

So that is a big part of it. We continue to manage the investment portfolio to help our interest rate risk position and our position at portfolio for a declining interest rate environment over the next handful of years as well.

Okay. Did I hear you right that just over $200 million in your adjustable-rate loans did not adjust with the last rate increase?

Yes, $255 million, Brad. There will be an additional -- if prime goes up one more time, there is an additional $20 million that will not reprice that has in the past. We're pretty much near the end of most of our ceiling.

Pretty much there. Okay. Then just lastly, if you could talk about the competitive landscape. I am always just curious what is happening in the Grand Rapids market, in particular with some of the big guys, whether it's Fifth Third or some of the smaller ones, that have come from other markets to try to compete with you. Then also what you are seeing in some of your newer markets, Holland and Lansing and Ann Arbor?

Brad, this is Mike. I think if you pick up on Gerry's comment earlier, what has happened mainly with some of the larger players is we have become, especially in Grand Rapids and Holland, a bigger and bigger player and have bigger and bigger market share.

We don't know the reasons why. We can only speculate that maybe they are tired of losing market share to us. I don't know. But we have had to walk away sometimes from deals that have been priced sometimes, as Gerry said, absurdly without really regard to the inherent credit risks that are in there. We really don't know why, I guess, that that's being done, but the fact is that it is happening and you can tell by the fact that we have been able to keep our margin pretty steady that we are just sometimes to the point where we have to let them go. And we will come back after them later when the service issues arise as they many times do.

So you are seeing some irrational pricing. Would say that's true not only in Grand Rapids but in some of the other markets as well?

I would say right now the most irrational pricing has been in Grand Rapids and Holland, although Howard Haas, our city president, and I talked about a deal that a large bank to -- not to be named right now --but priced a deal at 120 basis points over LIBOR the other day that just had no business being there. So we had to let it go.

It is kind of reared its head everywhere, but especially in Grand Rapids and Holland where I think we're even more known. I'm guessing here, but maybe the larger banks are just really tired of losing market share to us and so this is their best and only way to attack it.

And they're pressured to get growth. Thank you very much. Good quarter.

John Rowan, with Sidoti & Company. Please, proceed with your question.

If I repeat a question, forgive me. I had to jump off for a second. Chuck, just to be clear, it's 24% of floating rate loan portfolio is at ceiling, correct?

Correct.

And just one more quick question. Do you have the average interest-bearing liabilities for the quarter?

I don't have that, but I can get that to you.

I would appreciate it. That is all I had. Most of my questions were answered already. Thank you.

[Steven Gayan] with Stifel Nicolaus.

I was wondering if you're still writing caps into loans and what are those caps generally at? And kind of a second question, are you still seeing a shift into fixed-rate loans, and are you a bit surprised at that?

Yes, it's Mike. We still offer many times pricing on caps and floors on loans. It is really hard to generalize what that would be today, because a lot of it depends on the credit quality and the types of ancillary products and the total relationship that the customers have.

But they typically would be at their prime base caps or floor, anywhere from 2 over prime to 1.5 on the upside, and the same on the downside, but again I wouldn't want that to be generalized across the board on everything, because there are certain different relationships all the time. I am sorry, the second question was what?

Are you still seeing a shift into fixed-rate loans? I know you've had a jump here in the second quarter, but are you a bit surprised that -- companies coming forward with those requests?

It has definitely. As Chuck's comments indicated, we have seen our customers probably more than at any time in the last two or three years start to take some fixed-rate options. They, I think, believe that we are at the end of maybe -- we're not at the end of seeing the prices rise out there as far as the rate market goes. So we just again shift accordingly on our liability structure, and go from there.

One last question. In the past you mentioned a permanent branch or Lansing branch possibly opening in '07. Do you have any guidance on expenses over the next couple of quarters?

Steve, this is Chuck. We are onboard to open that facility which is currently under construction in the spring of 2007, probably sometime during the second quarter. We are still in the process of putting the building together, so we really haven't provided any specific numbers as of yet.

[Howell Ridley] with Security Financial Advisers.

Good job, guys, considering you have got some expenses this year that you didn't have last year and two new branches. I presume now you are $2 billion bank, seeing as you're very close to that a couple of weeks ago. So that is a milestone, also. Two specific questions. I guess number one, Gerry, when might you anticipate getting back to a, give or take, a 20% growth rate, sometime later this year? Is that in the cards?

Are you trying to send me to jail, Howell?

Well, you mean you haven't been there yet?

You got me close a couple of times; I will tell you that. You know, we basically have looked on our lender bonus, as an example, and we have stated this in other teleconferences, we really use a 15% period-over-period increase in earnings as the de minimis, if you will, where we start to accrue lender bonus.

We are -- and this is just anecdotal -- we're very hopeful that, as we start comparing the third quarter of this year with the third quarter of last year, that that 15% is going to be coming closer and closer to being achieved, because we will be comparing quarters that have like-expensive structures. But when we'll exactly hit that, Howell, I don't know, but we have not changed that in our bonus structure at all. It's still our target.

Okay. And your new markets, how is your noninterest income looking? Are you being able to sell some of your payroll services and some of your other services into your new locations?

Howell, this is Mike. I think in the newer markets, Lansing and Ann Arbor, which are the two you're talking about, things like payroll, we do sell it. Do we sell at the same rate that we do around here? No, just because we aren't as high profile yet in those markets.

Those two markets really, since they opened about a year ago, have spent a lot of time just out there blocking and tackling as far as getting some basic loan and deposit business in, and it has been especially helpful for us on the local deposit growth with both of those locations and especially Ann Arbor. I think that is the mission that we've had in those locations and, as we get from a marketing standpoint, if it's more well-known, we will see, as we did with Holland, an increase in some of those ancillary businesses, where we can drive the noninterest income from there.

One last question is what are the size of your loans in Ann Arbor and Lansing at this time?

I didn't bring that in with us for today to be exact, so I don't want to guess. But I can tell you that about 40% of our new volume was driven from those two markets, Lansing and Ann Arbor, which I think is pretty significant for the quarter. So both of them are doing very, very well and again especially, as I mentioned a minute ago, the Ann Arbor branch has done a really good job of developing some local deposit relationships.

Very good. That's all the questions I have. Keep up the good work.

Thanks, Howell. Appreciate your support.

Paul Woo, with Friedman, Billings, Ramsey.

A quick question for you, Chuck. When you had mentioned that there was lower bonus accrual, specifically for that executive management team bonus, was there any accrual for that this quarter?

No. That is the entire staff, excluding the commercial lenders.

Okay.

We are all on the same program.

And could remind me how that calculation is taken? Is it earnings per share, or is it net income after-tax?

That is net income after-tax.

Okay. So you are comparing this quarter to the second quarter in '05 that there wasn't a 15% period-over-period growth?

That's correct.

And I think just going back, there was no accrual taken in the first quarter also?

That's correct.

And the total amount for that bonus would be, I think, in 2005 it was $2 million?

The total for the whole year or just the first six months?

For the whole year.

A little over $2 million.

And just for a balance sheet growth going forward, what are you guys seeing in the loan pipeline? Is it still strong?

It looks, I think, real similar to what it did in December so, as we head into the second half of the year, you know, we are pretty optimistic of what is out there. If you've listened to some of the other questions and a couple of Gerry's comments earlier, you have some of the deals that sometimes look good in the pipeline fall away when some of the irrational pricing comes to bear. But, as you can see, we are still able to, as we always have during the history of this thing, put some pretty nice quarters-to-quarters together as far as asset growth.

And you had mentioned that composition was up. Was there any paydowns this quarter that was significant?

Yes, there is always paydowns. In the first quarter we mentioned during the teleconference, we had a really large watchlist credit paydown. We didn't have any one large one like that this quarter, but there were again some significant paydowns from projects that some of our real estate developers sold and that type of thing, as well as some smaller paydowns on the watchlist, but not one big event like there was the first quarter.

Very good. Thanks guys.

Ben Crabtree with Stifel Nicolaus.

Just a little bit, maybe a little bit of help on understanding the cap dynamics on the loan portfolio. I guess I am assuming that these loan agreements have a finite life. I'm just wondering if there is an effect coming up where some of these loan agreements mature and then would get repriced in a new environment? In other words, there might be a little bit of, if you will, a cure on the below-market rate simply from the passage of time?

Ben, this is Chuck. Great question. You know typically we balloon everything at five years, so the caps would have effectively a five-year cap on them.

We are starting probably more in the next year and going forward, we will start seeing those loans actually hit their five-year balloons. But most of those caps [and sors] are put on starting about three years ago, maybe four, some four years ago on some of them. So most of those caps and sors came into existence when rates started heading down the last time. We are probably about a year or two before we start seeing that on a significant basis.

And is that fairly typical of your markets, that your competitors tend to use those?

That's correct.

Then kind of a question, I guess just to make sure that I am -- that we have a better feel about the deposit trends. If I look at the noninterest bearing deposits and that is obviously something you have been emphasizing, if my numbers are correct here, it was a very strong sequential growth, extremely strong, but year-over-year still doesn't look like much. I wonder if you would be willing to hazard a guess as to what your kind of core underlying trend of growth in noninterest bearing deposits is, as likely to be this year, that sort of thing.

I will start on that and certainly if anybody else has any comments on that. One of the things you're seeing if you're looking at just specific day balances, say a quarter-end, actual day, we have a tremendous amount of volatility in that account everyday.

Our demand deposits probably on average go -- change, fluctuate by probably $3 million to $5 million, so in many respects if you're looking at just daily balances versus averages, the size of our demand deposits actually depends on what business day -- the actual calendar day that the end of the quarter happens to be on.

So that really starts throwing off some of the analysis there. I think if you look on an average basis, I think we're pretty similar this year to what we were last year. Some of our bigger DDA customers, our title companies, and a little bit of a slowdown their escrow account since we have -- they are not having as much activity. The balances are down a little bit. But we still have really good loan growth and obviously with all of our loans, we require the business deposits to come over. So we're still opening up a lot of accounts and expect some good things to happen from that, but obviously again, there will be some fluctuations in there.

Right. And then maybe just one last question to flip-flop to the other side of that equation. The use of wholesale funds is trending downward at kind of a moderate pace. I would imagine you've talked about this in the past, but where do you want that ratio to be? It is up in the '60s now. Where would you feel comfortable having it?

Obviously, as low as we can. We have seen a nice trend down. A lot of that decline in that number has been because we have gotten some really strong relationships with a lot of municipalities throughout all of our marketplaces, as well as continued business deposits in some of the businesses and business owners have significant deposits that they have brought over to us.

We have a maximum policy that we'd like to see internally. We don't really address that, but the number kind of is what it is. We go out and really allow the loan portfolio to drive the balance sheet. We have always been very opportunistic, so we're going to grab the loans, any loans that we can that are -- with appropriate credit risk and appropriate pricing, as we have already talked about today, and then grow local deposits through any means we have and then just bridge that gap with the wholesale funds.

We have been in the mid to upper '60s probably for the last five or six years. We certainly feel comfortable. I think, as you look at the Bank's historical performance, we have done very well with that level of wholesale funds. Again, we obviously want that as low as we can get, but it is a strategy that we feel comfortable with and certainly at these levels.

And actually if I could bend it a little bit here and ask one more on the loan side of that. The subject came up -- has come up a couple of times. It seems kind of strange to highlight loan growth as being only 15%. I mean it is lower than what you've done, but it is obviously very strong. I am wondering to the extent to which any of your changed, your alterations in the whole credit procedure had some sort of an effect on that number in the quarter?

Yes, it's Mike. It probably does from a standpoint of, you know, everyone wants to make sure because we have really emphasized that -- not that we haven't because you've looked at our numbers in nine years, they have been outstanding, but really emphasized the last couple of quarters that the assets we put on the books are up to Mercantile's standard. So there may be a few things that might have gotten booked that didn't get booked. But I think the bigger issue is one that Gerry and I both talked already, and that is, we have just been more careful to make sure that from a margin standpoint that if it is just too irrationally priced by our competitors that we walk away from it.

And competition is as difficult as it has ever been out there and it has never been easy since the day we opened the door. So I think those things all kind of come together as a confluence to maybe be a little less growth than we normally see, but most banks would line up and take our kind of loan growth all day long. So I don't want to be too down in the mouth or feel too sorry for ourselves.

Right. Thank you very much.

Jon Arfstrom with RBC Capital Markets.

Do you see any -- you talked a little bit about the second half of '05 expenses. Do you see any additional expense pressure in the second half of '06?

From our overhead perspective?

Yes.

No, we certainly have some position -- new positions that we budgeted that we'll hire, but no new plans to go anywhere else and the billing on our construction in Lansing won't open until next year. So it should remain relatively flat for the rest of year and there will be some minor increases certainly.

Great. You mentioned, Gerry, you mentioned disintermediation, I think, in your early comments. Chuck, can you just give us an update on some of your local market pricing? Are you still seeing the local market deposit pricing higher than the national rates?

Yes, Jon, without a doubt, especially on the CD side, and we picked up a lot of municipal deposits, but from a margin standpoint, they don't help a lot because with our municipalities, like most banks, they are pretty much pricing those at broker rates, which obviously are higher than your traditional CD rates. But across the board, even on the retail CDs, it is still relatively high. We certainly -- we would like to have to change, but we really don't forecast that at all.

And then one question on the Michigan economy. Are there any areas that you are avoiding, any types of businesses you're being more cautious with, and can you just -- relative to maybe a year ago, give us an update on what has changed in the Michigan economy. What is stronger and weaker?

I don't think there has been a lot of change in the last year as we see as far as particular industries, other than probably in the last two years, transportation has certainly come back from some really difficult times.

We continue to always be careful with -- and we always have, since we started the bank -- anything that has to do with automotive related pieces and parts because of the difficulties that, not only the big -- just the difficulties of that industry, but that hasn't really changed so much in the last year. It has always been a real challenge to make sure we are careful.

Thanks. That's helpful.

Gentlemen, we have no further questions at this time.

That will conclude our teleconference. Thank you all for dialing in. Have a good day.

Thank you. Ladies and gentlemen --

Thank you, Claudia.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.