Mercantile Bank Corp (MBWM) 2008 Q1 法說會逐字稿

Good day everyone and welcome to the Mercantile Bank Corporation first quarter earnings conference call. There will be a question-and-answer period at the end of today's 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 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, www.mercbank.com, which is M-E-R-C-B-A-N-K.com, on the conference today from Mercantile Bank Corporation we have Mike Price, Chairman, President and Chief Executive Officer, Bob Kaminski, Executive Vice President and Chief Operating Officer, and Chuck Christmas, Senior Vice President and Chief Financial Officer. 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. Price. Go ahead, sir.

Thank you and good morning everyone. Thank you for joining us today. As we mention add few weeks ago on our press release, management of Mercantile Bank sold a important to fortify our loan lost reserve as we identified weakness in certain commercial real estate and C&I loan relationships. While its increase provision for loan losses had a disappointing effect on our income statement for the quarter we felt the prudent action for these difficult times was to strengthen our loss reserves.

Today Chuck Christmas will start with a review of the financial statement and Bob Kaminski will follow with a detail report on a loan portfolio. We will then have a general Q&A session to end the call. Chuck.

Thanks, Mike and good morning everybody. What I would like to do, as I typically do is give an overview of Mercantile's financial condition and operating results for the first quarter of 2008, highlighting the major financial condition, performance, balances and ratios. We recorded a net loss of 3.7 million or $0.44 per share during the first quarter of 2008 compared to net income of 4.3 million or $0.50 per diluted share during the first quarter of 2007. The decline in first quarter earnings performance is primarily the result of a significantly higher provision expense in a substantial lower level of net interest income. The higher provision expense reflects the broad deterioration of the quality of our commercial loan portfolio reflecting a negative impact of Michigan's struggling economy on some of our borrowers cash flows and the reduction of collateral values.

Lower level of interest income primarily reflects the impact of the steep decline in interest rate that began in the late in the third quarter of 2007 with our near-term asset sensitive position whereby we have a higher magnitude of assets subject to repricing when compared to the level of liability subject to repricing combined with an increased level of nonperforming assets along with a very competitive loan deposit environment we have experienced a decline in the level of net interest income which has more than offset the modest growth in earning assets. Our net interest income during the first quarter of 2008 totaled $11.4 million, a decline of 3.1 million or about 21% from the 14.5 million recorded during the first quarter of 2007. Average earnings assets equaled $2.02 billion during the first quarter of 2008. That's an increase of about $62 million or about 3% from a level of average earnings assets during the first quarter of 2007. As usual, the growth in earnings asset was led by growth in total loans which accounted for 85% of the growth in earnings assets.

Our net interest margin during the first quarter of 2008 equaled 2.33% down from the 2.64% margin during the fourth quarter of 2007 and the 2.86% level recorded during the third quarter of 2007. The 53 basis point drop in our net interest margin since the third quarter of 2007, primarily reflects the steep decline in market interest rate that started with the collapse of the subprime residential real estate market during the late summer and early fall of 2007.

Since mid September of 2007, the FLMC has lowered the Federal Funds rates and there by the Prime Rate by 300 basis points or 3%. With about 60% of our loans tied to floating rates, we have experienced a significant decline in our yield on assets. Our asset yield is done about 135 basis points since the FLMC first rate reduction led by a 170 basis point decline in the yield on our loan portfolio. Although current market sentiment is that the FLMC is nearing an end to interest rate cut it does appear that they will lower rates one or two more times which will have an additional negative impact on our asset yield.

We have also seen a significant reduction in our cost of funds but just not to the degree of the decline in our asset yield. While our asset yield have gone down about 135 basis points since September of 2007, our cost of funds has declined by about 80 basis points. While deposit in borrowing rates have declined our relatively high reliance on fixed rate certificate of deposit and federal home loan bank advances result in a late reduction of our cost of funds. With about $600 million in relatively high rate wholesale funds scheduled to mature during the remainder of 2008 and other 360 million maturing during 2009, we do expect our cost of funds to continue to decline throughout 2008 and into 2009. These maturing wholesale funds carry an average interest rate of about 5% compared to current interest rates ranging from 2.50% to 3.75% depending on type and term of product.

Given the multitude of factors that impact the net interest margin such as FLMC decisions, corresponding changes in interest rate for deposits and borrowed funds, shape of the yield curve loan deposit competitive environment, changes in balance sheet structure, level of nonperforming assets and potential changes in interest rate risk management strategies, it is difficult to predict future net interest margin. However, under the current interest rate environment whereby it appears the FLMC is nearing the end of interest rate cuts our net interest margin should begin to improve as we move into the second part of 2008.

The provision expense during the first quarter of 2008 total 9.1 million far exceeding the 1.0 million expensed during did first quarter of 2007. Our loan loss reserve totaled just under $30 million at the end of the first quarter or about 1.67% of total loans. Our reserve equals 1.43% of total loans at year end 2007, and 1.24% of total loans back a year ago. Bob will have specific and more detailed commentary on asset quality later during the conference call. Noninterest income totaled $1.9 million during the first quarter of 2008, an increase of 0.5 million or about 34% from the 1.4 million earned during the first quarter of 2007. We recorded increases in virtually all (inaudible) income categories led by $128,000 increase in mortgage banking activity fee income and $115,000 increase in service charges on deposit accounts.

Noninterest expense totaled $10.3 million during the first quarter of 2008 an increase of 1.6 million or about 18% from the $8.7 million expensed during the first quarter of 2007. Growth in salary and benefit cost totaled 0.4 million primarily reflecting annual salary increases and an increase in staff size from 295 FTEs to 311. About 1.5 of the increase in staff size is associated with our expansion at Oakland County during the fourth quarter of 2007.

Growth in occupancy, furniture and equipment cost total $250,000, primarily reflecting the opening of our new facility in Lansing during the second quarter of 2007 and the foremention expansion in Oakland County during the fourth quarter of 2007. Growth in other overhead cost totaled $0.9 million with about two-thirds of that increase associated with the administration and resolution of problem assets and the increase FDIC insurance premium assessment.

Our funding strategy has not changed significantly as we continue to grow local deposits and bridge any funding gap of wholesale funds namely brokered CDs and Federal Home Bank advances . Average wholesale funds to total funds in the first quarter averaged 61% the same level as it was in the first quarter of 2007. Given the lower interest rate environment on Federal Home Bank advances when compared to the brokered CD market we continue to replace some maturing brokered CDs with Federal Home Bank advances and will continue to do so if current interest rate environment remains unchanged.

Mercantile remains in a well capitalized position for bank regulatory definition with a total risk-based capital ratio at the end of the first quarter of 2008 of 11.3% down slightly from 11.4% at year end 2007.

That's my prepared remarks. Be happy to answer any questions in the Q&A session. I'll turn it over to Bob.

Thank you Chuck. My comments this morning will focus on the various aspects of the banks loan portfolio. During the fourth quarter 2007, Mercantile personnel undertook a review of the bank's loan portfolio with a special focus on residential real estate development and construction loans. During the first quarter we continued to see some deterioration in development loans. Some loans which have been downgraded in rating during the fourth quarter experienced further downgrades in the first quarter. Additionally, we started to see some concerning deterioration in the commercial real estate and commercial and industrial segments of the portfolio. Consequently, in late first quarter, Mercantile lending staff and review staff conducted a comprehensive review of the loan portfolio focusing on those segments which exhibited any signs of weakness, including industry, location, lender, previous performance, et cetera. The result was the prudent identification and downgrade of some credits in the portfolio which necessitated the significant provision expense by the end of the first quarter.

First I'll give you some general statistics on the loan portfolio. During the first quarter Mercantile saw a slight contraction in the total loan outstandings from $1.8 billion at the end of fourth quarter to just under 1.8 at the end of the first quarter. Loan lost reserve at the end of March, stood at 29,956,000 compared to 25,813,000 at the end of fourth quarter. Reserve stood at 1.67% compared to 1.43% at the end of last year.

Next I will give some detail on the 9.1 million provision expense taken in the first quarter by providing the allocation based on loan type. Of the $9.1 million provision $890,000 was allocated for credits related to land development; $280,000 was allocated for one-to-four family construction credits; $250,000 was allocated for commercial construction credits; 800,000 was for one-to-four family mortgage that was primarily [nonowner] or occupied credits; $400,000 was for multi-family credits; $1.2 million was commercial real estate, owner occupied; $1.78 million was for commercial real estate nonowner occupied; and just over $3.5 million was allocated for a commercial and industrial credits for a total of about $9.1 million.

As we have stated during the first quarter, Mercantile had gross charge-offs $5.1 million, of that amount, $2.1 million related to impaired amounts on loans established as of December 31, 2007. An additional 500,000 related to charge-offs of increased impairments on those same loans for total of $2.6 million in previously identified impaired loans. Another $981,000 related to the devaluation of real estate collateral values from previous appraisals and other valuations on distressed credits. Further detail on first quarter net loan charge-offs is as follows. As we mentioned we had just over $4.9 million in net charge-offs for the quarter. Of that amount, $1.70 million related to land development and residential lot loans; $192,000 related to one-to-four family construction; $439,000 related to one-to-four family housing, primarily nonowner occupied, rental; commercial, owner-occupied $368,000; commercial, nonowner-occupied of $1.4 million; commercial industrial $1.4 million, and other about $10,000, again, for our net total of just over 4.9 million.

Regarding nonperforming assets, at March 31, Mercantile had $40.6 million in nonperforming assets that consisted of 35.2 million in nonperforming loans and 5.4 million in ORE and repossessed assets. The break down of nonperforming assets by loan type compared to last quarter is as follows. For March we had $10.1 million in nonperforming assets in land development and residential lot loans that compared to 8.6 million at the end of December. In March we had 3.0 million in one-to-four family construction compared to 3.1 in December. Commercial construction we have 300,000 in March compared to 0 in December. One-to-four family residential we had 4.3 million compared to 3.2 in December. Commercial owner-occupied we had $8.7 million in nonperforming assets compared to 6.5 million at the end of December. Commercial nonowner-occupied we had 7.3 million at the end of March that was unchanged from December. Commercial and industrial we had 6.9 million at the end of March compared to 7.1 at the end of December again for a total in March of $40.6 million.

Further stratification of a nonperforming asset change from fourth quarter to first quarter is as follows. As of December 31, we had just over $35 million in nonperforming assets. We had new additions to nonperforming asset list of $12.6 million during the first quarter. We had pay downs on nonperforming assets of just over $3.4 million and we had charge-offs of 4.3 million of nonperforming assets in the first quarter for a net increase of $4.9 million in nonperforming assets.

I want to give you some detail on the loan portfolio as a whole by loan type. Of our just under $1.8 billion in outstanding loans, we have $141 million in land development vacant lot loans. We had 54 million in one-to-four family construction. We had 75 million in commercial construction; 133 million in one-to-four family residential, again, much of that nonowner-occupied rental; 53 million in multifamily. We had $370 million in commercial owner-occupied. And we had 485 million in commercial nonowner occupied and finally, 465 million in commercial and industrial.

Regarding past due under 90 days, past due is less than 90 days saw a decrease of, just over 4.0 million at the end of the first quarter compared to December. At December 31, we had $7.1 million in under 90 day past due that dropped to 3.0 million at the end of March for just over $4 million decrease.

Additions to the past due under 90 day category was $1.7 million, pay downs and loans coming off that list was $3.7 million,transfers to nonperforming $1.6 million; and charge-offs 538,000 or again, a net decrease of $4.0 million in the past due under 90 days.

Mercantile loan personnel continued to work diligently to excess the ongoing risk to the portfolio, distressed credits and other relationships demonstrating some signs of weakness are the targets of frequent communication and contact by the lenders. Loan ratings and trouble credit strategies are part of an extremely fluid process. Credits are continually evaluated to ensure that the overall relationship is appropriately assessed and to answer the question as to whether it is a viable borrower. Credits viewed to have questionable liability are targeted for exit from the bank. Other credits where strained cash flows have put the retailment on loan in peril, the borrower and where the borrower and the bank cannot agree upon a liquidation plan, those loans are subject to remedies involving the legal process. That concludes my prepared remarks I will be happy to answer questions during the Q&A. Mike.

Thank you, Bob and thank you Chuck. At this time we would like to open up for any questions.

Thank you, sir. (OPERATOR INSTRUCTIONS). We'll go first to Terry McEvoy of Oppenheimer.

Good morning.

Hi Terry.

The past couple of quarters in the press release and in the conference call, what you were really talking about is spending a substantial amount of time and really going through the loan portfolio and trying to identify potential problems down the road which was kind of signaling to me more of a one-off clean-up quarter and then in today's release and on the call now it seems like it was business as usual, a typical quarterly review of loan quality and unfortunately resulted in $5 million so was this just a typical quarter or was it like we have seen over the past couple quarters where you felt you were very aggressive in reviewing the portfolio and we can read into maybe into the future times improving a bit?

That's a big question Terry. As Bob mentioned in his comments and the last conference call we did, in the fourth quarter we spent an awful lot of time because there was an awful lot of signal that we had some residential real estate development issues. We were pretty aggressive, very aggressive in the fourth quarter identifying those, providing for those and in fact, we had a slightly -- we had a little more deterioration in the first quarter of that particular slice of the portfolio but not a real significant number. However, what did happen in the first quarter as we move through the first quarter we started to become aware of, and I think Bob detailed it, I won't go through all the different areas but we started to become aware of some of the commercial loans, C &I type of relationships that we saw some deterioration. Obviously, the economy isn't getting any better at this point and we want to be pro active on the rest of the portfolio in the same way that we were with the residential real estate in the fourth quarter. So you can see that even though we took a very large provision of over $9 million in the total relationship of things, the number of nonperforming assets didn't significantly increase, but clearly I think you can take away from the fact we are trying to be very conservative on this and very proactive and get ahead of the curve as far as looking at the rest of the portfolio just like we did in the fourth quarter with residential real estate.

One other question if I could. Just looking at who compete with in Kent County a fair amount of those banks had some capital issues in place. Are you noticing a change competitive behavior among some of those bigger banks because of their own internal challenges are they still very aggressive in trying to win the business?

It's varies almost from week to week. I think competition out there is still very good and very strong and that has always been the case and we always expected to be the case. But we do some some of the larger players backing away from deals that we know we would have gone for a year ago, but of course that could be said of us as well. There are certain segments of the economy and certain segments of borrowers that right now you just really don't want to have an appetite for. But overall I would say still very competitive out there but we do see as I mentioned in prior conference calls we do see some rationality coming back in deal structure and to guarantees and collateral and that type of thing. It makes it's a much more a rational landscape out there but there are still banks out there that we are not really sure how they come up with a pricing that they've come up with on some of the loan deals and as you can tell by our slowing of our growth, that is combined when we walked away from some of those deals, that's combined to slow our growth down because we clearly don't want to put anything on the books, not that we ever did but we clearly are very careful at this point to trying to put only deals on that not only are good from a safety and sound standpoint but also from making money for the bank.

Thanks for the call. I appreciate it.

Thank you.

We'll take our next question from Eileen Rooney of KBW.

Good morning guys.

Good morning.

Just a question on the margin. I was wondering if you could quantify that a little bit for us just in terms of what was related to the nonperforming asset, interest reversal versus the asset yield repricing.

I think we you look at our overall margin and I compared to more historical levels of nonperforming there's probably about 10 to 15 basis points of a negative impact with the increased in nonperforming when you look at the average nonperforming level during the first quarter. As far as interest reversals, we probably have about -- it's a difficult number to give you because some accrual took place during the first quarter but about 150 to $200,000 in reversal prior period interest accruals. As Mike already touched as well as Bob we didn't have a huge increase in nonaccruals during the quarter. So there wasn't a whole lot of reversals. So the biggest impact on asset quality, with regard to the margin is just the increase in nonperformers.

Just thinking about the margin going forward, are you starting to hit any floors on any of your loan portfolio, any of the deals there?

Yes. We wish we had more of them certainly but we are starting to hit them a little bit but it's not going to hit ( inaudible) it's there but it's not very very significant.

And just one final question unrelated. I saw your press release this morning about the dividend for the second quarter. Should we think about that, is that just for the second quarter? Is that a decrease in the quarterly run rate?

This is Mike. The bank, the board and the management team will be looking at on a quarter-by-quarter basis in consideration of any dividends going forward, whatever that dividend rate would be and as you might imagine that decision will be made based upon our capital position, earnings for the quarter and the quarters that we see going forward.

Great. Thanks a lot, guys.

(OPERATOR INSTRUCTIONS). We'll go next to Daniel Cardenas of Howe Barnes

Hi, guys.

Hi Dan.

Can you give us a little bit of color on your NPAs in terms of how many of those are still performing and then also if you can give us a geographic breakdown as to the increase we saw on this quarter. Is it in the Grand Rapids area, is it in Lansing, in Ann Arbor, or Oakland?

This is Bob. A significant portion of our nonperforming asset continue to be contractual or current , I think it's in the range of 25 to 30% of those assets. That is encouraging and consistent with the statistics we cited in previous calls about our posture with regards to nonperforming assets, with regard for the location, I think obviously, the greatest concentration of nonperforming assets is in the Grand Rapids (inaudible) which is our biggest presence continues to be. We have seen some signs of some distress in our outline regional markets and we'll continue to work with them. But by significant portion those assets are concentrated in Kent County.

How much of your portfolio have you reviewed? Can we expect some additional review in this quarter and perhaps some -- larger than anticipated provision levels going forward?

We'll review it as an ongoing process Dan and it's a very fluid process where some of those credits that we have reviewed in December, we are revisiting those things quarterly sometimes monthly to make sure we have arms around of the continued performance of the credit. Some of these credits are such that there are things that change regarding the performance on a month to month basis so a lot of credits we look are an ongoing basis some as much as monthly. Certainly, our watch list we look at monthly, other credits that come to our attention that were subject to our review during -- during the first quarter are some of the credits as I mentioned, regarding specific industry, location, performance of lenders, portfolios, and so we are working aggressively to make sure that we watch any signs of any weakness or anticipate any potential weakness based upon performance of other credits within the industry and pull those files and get with those customers that are of similar structure to see if those credits may be undergoing similar signs of weakness or distress. It's a very fluid process, it's ongoing. It's not a point of time review that we'll say we are done. It is something that we are doing every day.

Can you give us some color on your watch list trends?

Watch list trends are certainly up, I think with the downgrades that I mentioned going over the allocations based on the $9.1 million provision ( inaudible ) the watch list is up and again we felt it prudent based upon the signs of distress that we elevate to watch list trend or we downgrade to watch list status so we can keep a closer eye and gain more accountability from the borrowers as to the performance of the companies.

We spent a lot of time with our lenders staff in the last quarter and saying look if you have any just like we did with the fourth quarter, when you look to the rest of the portfolio if you have any doubt, on the side of being conservative and downgrading the credits and we had our senior management team and our senior lenders go through anything that would signal to us by loan review or by those lenders to kind of do a secondary review of okay what do we have here, and I can tell you that we had far more downgrades than we did any upgrades or passes when we looked at some of those credits that concerned our lenders on the street, if you will.

Thank you.

(OPERATOR INSTRUCTIONS). We'll go next to Stephen Guyan of Stifel Nicolaus.

Good morning. Just have you extended the duration of wholesale funding? Just wondering how that looks. You talked about the specific dollar amount and the rest of 2008 and into 2009.

Yes. This is Chuck. Historically the average maturity of our wholesale portfolio has within -- bouncing around between eight and ten months and as you look back to late Summer and early Fall when we wish it would have been two months but it wasn't. It's probably -- I haven't calculated it recently. My guess is closer to 10 to 12 months currently, and what that does is it reflecting that especially on the Federal Home Bank advances, because those rates are low, we are starting to extend some of our liabilities. You can extend your liability in the Federal Home Bank side at rates that are cheaper than the shorter term on the broker CD side of things. We are doing a bar bell approach. We are doing shorter term CDs but longer term Federal Home Bank advances and as you saw from our numbers, the dollars of our Federal Home Bank advances have been increasing in those will continue to increase. There is a limit with regard to our collateral we can go up to $300 million but we have some room to increase there. Long-term average, probably 8 to 10 months. Right now we are a little bit on the higher side but as we speak now and as I mentioned as we go through our strategy to lengthen out some of those liabilities. Certainly, at some point, in the future of the Fed will have to raise rates and if we can push those liabilities out without having a big huge increase in cost in the near-term that will pay some dividends for us if we do get an increasing interest rate environment, which eventually we will do.

Okay. The other income was up from fourth quarter. Part of that was from mortgage banking. Can you go over that again where you saw the increase?

About, $128,000, Stephen, in increase in mortgage bank activity and this primarily a big increase in refies . As rates really hit pretty big lows late January and February and part of March. A lot of refinance activity. Many banks-- similar numbers I would think just because it's more interest rate driven. I would tell you that many many more people wanted to refinance but had difficulties in doing so because of the appraisal issue. If people got their current mortgages say within the last 12 to 24 months with appraisals back then, when the houses are being reappraised certainly there are some declines and it can be difficult if not impossible for some borrowers to be able not to refinance at that 80% number, because they would actually come down with an additionally payment on that loan..

Okay. And also you mentioned during the first quarter credit review you had looked at various connections between industry lender. Did you come up with anything that kind of raised your eyebrows or was there any connection or mostly just across the board?

What we tried to do is look at any parts of the portfolio that could be possibly connected whether it would be industry or a specific lender portfolio or location and to look for trends, and we start today see a couple of loans that popped up in any categories we took a broader view and looked at other loans within those same segments to make sure that we weren't missing anything. In terms of the breadth of the downgrades as you can see it's really across the board with the greatest concentration in the areas of C&I and commercial real estate during the first quarter. That was the most concerning trend that we had from a problem that obviously was focused primarily on residential development late last year.

Okay. Thanks.

And gentlemen, we have no further questions at this time. I'll turn the call back over to you.

Thank you. Again we recognize it's very difficult quarter, but we, one of the things we didn't talk a lot about during this conference call was a lot of the good things that are happening at the bank and it gets over shadowed sometimes but we continue to gain a lot new customers, a lot of good business coming into the bank. We are working very, very hard to see some good days ahead here in the upcoming quarters. So we appreciate your interest in Mercantile Bank and at this point we will end the call. Thank you.

That does conclude today's conference call. Thank you for your participation. You may disconnect at this time.