Mercantile Bank Corp (MBWM) 2008 Q3 法說會逐字稿

Welcome to the Mercantile Bank Corporation third quarter earnings conference call. As a reminder, today's call is being recorded. 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 and 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 assumed 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. On the conference today for Mercantile Bank Corporation we have Mike Price, Chairman, President and Chief Executive Officer, Bob Kaminski, Executive Vice President and Chief Operating Officer, Chuck Christmas, Senior Vice President and Chief Financial Officer. We will begin the call with Managements prepared remarks and then open the call up for questions. At this point I'd like to turn the conference over to Mr. Price. Please go ahead, sir.

Thank you. Good morning everyone and thank you for joining us today. We are very pleased to announce the return to profitability this morning, while the unprecedented conditions facing banks and the economy virtually guarantee more challenging quarters in the near future, the picture here at Mercantile is one of slow and steady progress as to asset quality and profitability and a continuation of our well-capitalized position. We have been focusing on margin and asset quality improvement for over a year now and I am pleased to report this quarter showed positive trends in both areas. Chuck Christmas will present the break down of our financial report, including the update on our margin and the challenges that we continue to face given the recent Fed actions. Bob Kaminski will follow with a very detailed overview of the dynamics of our loan portfolio, loan loss and loss provision, and then we will have a question and answer session for you. So at this time I'd like to turn it over to Chuck.

Thanks, Mike and good morning everybody. What I'd like to do this morning, as typical, is give you an overview of Mercantile's financial position and operating results for the third quarter of 2008 and the first nine months of this year as well highlighting major financial condition and performances balances and ratios.

We recorded net income of $1.1 million or $0.13 per share during the third quarter of this year compared to net income of $2.4 million or $0.28 per share during the third quarter of last year. However that is a significant improvement from the net loss of $2.6 million recorded during the second quarter and a net loss of $3.7 million recorded during the first quarter of 2008 due to a much smaller provision expense and an improved level of net interest income. We recorded a net loss of $5.3 million or $0.62 per share during the first nine months of this year compared to net income of $8.9 million or $1.05 per share during the first nine months of last year. The decline in net income in the comparable period is primarily the result of a significantly higher provision expense and a substantially lower level of net interest income.

The higher provision expense primarily reflects the negative impact of state, regional and national economic struggles on some of our borrowers cash flows and the reduction of underlying collateral values. The lower level of net interest income primarily reflects the impact of the steep decline in interest rate that began in the late 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 non-performing assets along with a very competitive banking environment we have experienced a decline the level of net interest income which is more, it has more than offset the growth in earning assets.

Net interest income during the third quarter of 2008 totaled $11.7 million, a decline of $2.4 million from the level during the third quarter of 2007; however, it is $1.1 million higher than the second quarter of 2008 and $300,000 higher than the first quarter. Net interest income during the first nine months of 2008 totaled $33.7 million a decline of $8.8 million from the level earned during the first nine months of 2007. Average earning assets equaled $2.07 billion during the third quarter of 2008, an increase of almost $82 million from the level of average earning assets during the third quarter of 2007. As usual, the growth in earning assets was lead by an increase in total loans which accounted for over 96% of the growth in earning assets. Our net interest margin during the third quarter of 2008 equaled 2.30%, up from the 2.15% margin during the second quarter of 2008 and similar to the 2.33% margin during the first quarter of 2008. The net interest margin was 2.86% during the third quarter of 2007. The 56 basis point drop in our net interest margin since the third quarter of 2007 primarily reflects the steep decline in market interest rates as reflected by the 325 basis point drop in the prime rate from mid September of last year through springtime of this year.

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 down about 160 basis points over the last 12 months, lead by 180 basis point decline in our yield on our loan portfolio. The recent 50 basis point prime rate reduction will place additional pressure on our loan and asset yield; however, recent loan pricing initiatives will help to mitigate the impact. Also, at least from a short-term perspective, about 18% of our floating rate loans are LIBOR based and those loans have recently repriced significantly upwards. Most of our LIBOR based loans are tied to the one month LIBOR rate and reset on the first business day of each month. 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 has gone down by about 160 basis points over the past 12 months, our cost of funds has declined by about 100 basis points. While deposit and borrowing rates had declined our relatively high reliance of fixed rate certificates of deposit and Federal Home Loan Bank advances resulted in a lagged reduction in our cost of funds. With about $275 million in relatively high rate wholesale funds scheduled to mature during the remainder of 2008 and another $765 million maturing during 2009, we do expect our cost of funds to continue to decline throughout the remainder of 2008 and into 2009. These maturing funds carry interest rates that generally range from 50 to 100 basis points above current market interest rates. Although we originally were hopeful to see a further increase in our net interest margin during the fourth quarter, the recent 50 basis point reduction will likely result in a net interest margin during the fourth quarter similar to that of the third quarter. Additional prime rate reductions would further negatively impact our asset yield; however we are hopeful that continued reductions in our cost of funds will result in an improving net interest margin in 2009. But the extreme volatility in the financial markets makes it very difficult to forecast net interest income and net interest margin with any precision.

The provision expense for the third quarter of 2008 totaled $1.9 million, a decline of $0.9 million from the level of expense during the third quarter of 2007. The $1.9 million also represents a substantial reduction from the $6.2 million expensed during the second quarter of 2008 and the $9.1 million expensed during the first quarter of 2008. The provision expense in the first nine months of 2008 totaled $17.2 million, an increase of $11 million from the $6.2 million expensed during the first nine months of last year. Our loan loss reserve totaled $29.5 million as of September 30, 2008, or 1.58% of total loans. Our loan loss reserve equaled 1.73% of total loans at the end of the second quarter of this year and 1.38% of total loans a year ago. The reduction in the coverage ratio as of the end of the third quarter of this year in comparison to the coverage ratio as of the end of the second quarter of this year primarily reflects the charge off of specific reserves established in prior periods which equaled about 66% of total charge-offs during the third quarter. Bob will have specific and more detailed commentary on our asset quality and loan portfolio later during the conference call.

Non-interest income totaled $1.8 million during the third quarter of 2008, an increase of $0.3 million or about 21% from the $1.5 million earned during the third quarter of last year and non-interest income totaled $5.5 million during the first nine months of this year, an increase of $1.2 million or about 26% from the $4.3 million earned during the first nine months of last year. We recorded increases in virtually all fee income categories. During the first nine months of 2008 compared to the first nine months of last year, the service charge income was up $288,000, mortgage banking activity income was up $175,000, and bank owned life insurance policy income was up $381,000.

Non-interest expense totaled $10.5 million during the third quarter of 2008, an increase of $0.9 million over the $9.6 million expensed during the third quarter of last year. Non-interest expense totaled $31.6 million during the first nine months of 2008, an increase of $3.3 million over the $28.3 million expensed during the first nine months of last year , adjusting for the one-time expense during 2007 associated with retirement of our former Chairman and CEO, the increase in 2008 totaled $4.5 million. The majority of the non-interest expense growth during the first nine months of 2008 compared to the same time period in 2007 relates to costs associated with the administration and resolution of problem assets including legal costs, property tax payments, appraisals, and writedowns on foreclosed properties. These costs totaled $0.8 million during the third quarter of this year and $2.3 million during the first nine months of this year. During the first nine months of 2007, this cost totaled only $0.6 million. One other expense item of note is increased FDIC insurance premium assessment, an increase of $0.6 million during the first nine months of this year when compared to the first nine months of last year.

With regards to funding, our funding strategy has not changed significantly as we continue to try to grow local deposits and bridge any funding gap with wholesale funds, namely brokered CDs and federal home loan and bank advantages. Our average wholesale funds to total funds during the third quarter of this year was 67%, an increase from the 63% average in the second quarter and the 61% average during the first quarter of this year. Increases in wholesale funds reflect a combination of asset growth and a reduction of local funds. The reduction in local funds is due to a variety of factors, primarily including depositors having less available funds for deposits especially within regards to public units, depositors making decisions based on FDIC insurance limitations and more importantly, very high rate offerings on CDs by competitors. Currently some banks that are market are offering rates that are 100 basis points of broker grade. The brokered CD market remains very liquid and we continue to raise funds as needed at reasonable costs.

With regards to capital, we remain in a well capitalized position per bank regulatory definition with a consolidated total risk-based capital ratio of 10.9% and a bank total risk-based capital ratio of 10.7% at the end of the third quarter. The bank's total regulatory capital equaled about $226 million as of September 30, approximately $15.3 million in excess of the amount needed to provide for the 10% minimum while capitalized total risk-based capital ratio. That's my prepared remarks. I'll be happy to answer any questions in the Q & A session, but now we'll turn it over to Bob.

Thank you, Chuck and good morning. My comments this morning will focus on the bank's asset quality and some other information on the loan portfolio. I'll start with a review of asset quality headlines from the past several quarters. In the second half of 2007, we witnessed a deterioration in the residential Real Estate and development and construction loan portfolios. In the first quarter of 2008, there was continued deterioration of residential real estate plus we identified some deterioration in commercial real estate and commercial and industrial loans. In the second quarter of '08 there was a continued deterioration of commercial real estate loans previously identified as distressed including some significant charges taken for the degradation of real estate property values. In the third quarter of' 08 some previously identified impaired loan losses were charged off.

Additionally, the bank identified some loan upgrades in pay-offs that helped offset the reduced influx of new problem loans. With regard to the loan portfolio balance, at the end of the third quarter, we were $1.87 billion compared to $1.8 billion at the end of 2007. As Chuck mentioned the loan loss reserve was 1.58% of the portfolio compared to 1.73% at the end of June and compared to 1.43% at the end of 2007. With regard to the $1.9 million provision expense taken in the third quarter, I'll give you a break down based on loan type. Up at $1.9 million provision there were $503,000 taken for land development loans with the benefit of $51,000 for one-to-four family construction, $51,000 of the provision was allocated for commercial construction, $591,000 was for family mortgage primarily non-owner occupied, $3,000 for multi-family. There was a benefit of $292,000 for commercial real estate owner occupied, $801,000 was for commercial Real Estate non- owner occupied, there was a benefit of $20,000 for commercial industrial loans, loans to individuals was $15,000 and we had just under $300,000 allocated of the provision for growth that took place during the quarter, for a total again of $1.9 million.

Charge-offs during the quarter. Third quarter net loan charge-offs totaled $4.3 million. Of that amount, $3.0 million related to impaired loan amounts on loan losses established as of June 30. Further detail on the third quarter charge-offs are as follows. Land development loans, residential lots was $33,000. Commercial land development just over $1 million. One to four family construction, $270,000, one to four family $354,000, commercial owner occupied $114,000, commercial non-owner occupied $249,000, commercial industrial $2.2 million, and various other loans $16,000, again for net charge-offs just under $4.3 million.

With regard to non-performing assets, at September 30, Mercantile had non-performing assets of just under $48 million. $42 million was non-performing loans and $5.7 million was consistent of other real estate and repossessed assets. The break down of non-performing loans by loan type compared to last quarter is as follows. In September we had non- performing assets for land development residential lots of $13.9 million, that compares to $12.4 million at the end of June. Commercial land development, we had $2.3 million compared to $3.5 million at the end of June. One to four family construction, $2.0 million compared to $2.3 million. One to four family, we had $5.2 million compared to $3.2 million at the end of June. Commercial owner occupied, $5.3 million compared to $7.0 million at the end of June. Commercial non-owner occupied, we had $14.4 million compared to $10.2 million at the end of June, and finally commercial industrial, we had $4.7 million at the end of September compared to $8.0 million at the end of June. Again, for the total of just under $48 million in non- performing.

Further stratification of the non-performing assets changed from the second to third quarter is as follows. Third quarter we finished just under $47 million. We had new non-performing assets added during the quarter of $11.5 million. We had pay downs of $6.5 million and we had charge-offs of those non-performing assets of just under $3.8 million. For a net increase of just over $1.1 million. Of the pay downs of the $6.5 million that I mentioned, $3 million came from upgrades of credit back to performing status, and $3.5 million came from pay offs and pay downs on non-performing assets. The bulk of the $11.5 million in additions to non-performing assets during the quarter came from four relationships totaling $8.6 million. Of the $8.6 million, $6.2 million consists of commercial real estate, the rest is residential real estate related. The remainder of the non-performing asset increase came from smaller C & I and commercial real estate credits.

Loan portfolio stratification by purpose code, I'll give you some color on that. In September, we had $135 million in land development and vacant lots. One to four family construction we had $49 million, commercial construction $93 million, one to four family homes $141 million, multi-family, $51 million, commercial owner occupied $360 million, commercial non-owner occupied $508 million, C & I, $518 million, and other miscellaneous loans, $16 million and for a total portfolio of $1.8 billion. Past due less than 90 we saw an increase of $4.8 million at the end of the third quarter compared to June 30. That compares to favorably to December 31 where we were at $7.1 million. Reconciliation of that, we had additions to the under 90 day category of $5.8 million, we had pay downs and removals of $555,000. We had transfers to non-performing of 263, charge-offs of $144,000, or again for a net increase of just under $4.9 million. That's the end of my prepared remarks.

I'll turn it back over to Mike.

Thank you, Bob. If you closely followed our Company, you'll know that we were one of the first banks to anticipate asset quality uses and also one of the first banks to start to increase our loan loss provision for the same. As I mentioned a year ago we knew there were inherent problems in almost all bank loan portfolios as to Real Estate development and Real Estate values. We pledged early recognition, conservative analysis, and relentless pursuit of resolution of our problem assets, knowing that they take time to work through. We feel that this quarter, where the required loan loss provision decreased substantially from the last two quarters due to some upgraded credits and the slowing of new loans entering non-performing status, may be the first sign of stabilization of asset quality at Mercantile. While I'm cautiously optimistic, I remind everyone that these are unprecedented times and while we have made outstanding strides with numerous problem credits, there remains intense strain in the system. We pledge to all stakeholders the same focus and conservative approach tha has held us in good stead to date. Before I turn it over to Q & A, I'd like to thank our customers who remain very loyal during a time of great concern in our country and certainly to our employees who performed with utmost skill and dedication, so at this time I'd like to turn it over for a Q & A session.

Thank you. (OPERATOR INSTRUCTIONS). We'll take our first question from Jon Arfstrom from RBC Capital Markets.

Thanks, good morning guys.

Good morning.

Nice job considering the environment.

We're getting there.

Just a quick housekeeping question for you Chuck. Did you say 18% of your loans are tied to LIBOR or 18% of floating rate loans?

18% of floating rate.

Okay, good. In your prepared comments you talked about depositors, deposit competition at other banks up to 100 basis points higher in the local markets. I'm guessing you wouldn't name names but can you just talk a little bit about the profile of the banks? Are they larger banks? Smaller banks?

Definitely don't want to name names in this venue but I'd say it's the larger organizations. Smaller ones in large degree are having to follow. We haven't chosen to do that. Again, there's the reliance on, the increased reliance on the wholesale funds. Obviously we don't want to increase the reliance but certainly don't want to pay 50 to 100 basis points more for the money either.

Okay. And then you talked a little bit about one of the reasons for a reduction in your local deposits was some FDIC insurance limits and I'm just wondering if raising that cap or I guess it's really an unlimited amount for non-interest bearing, does that change your appetite at all, or does it allow you to do things?

Hopefully, certain depositors in all banks certainly hasn't escaped have been very worried about the banking industry as a whole and have taken money out of Mercantile and placed it with other institutions locally. We also, I think as most people know, we have a partnership with Raymond James brokerage and our brokerage area has gotten quite a bit of that money and has placed it into the brokered market for those customers hopefully just for a short-term period we can get that back. Certainly the increase in the 100,000, the 250,000 helps us because it just means that depositors will be willing to put more money with Mercantile Bank. With regards to the non-interest proposal this morning, haven't had a chance to look at it totally. I do know there's going to be fees, it does look like there's going to be fees associated with the FDIC assessment so we'll have to take a look at that. Most of the money that we have lost on the deposit side is either in the savings accounts or the CD accounts. The most of the money that has left a DDA account has actually gone into our sweep program so it's still on the balance sheet. Instead of earning 0% it's earning about 2% in our sweep account.

Good. That's helpful and just one more question. You talked a little bit about your loan pricing initiatives from last quarter, and could you talk a little bit about how much that is contributing versus perhaps what the market is giving in terms of higher spreads and maybe give us an idea of what kind of spreads you're getting on the loans than you were a year ago?

Jon, this is Mike. Awhile back, I'm going to say probably about six months ago, we really undertook, looked at the market and looked at the fact that the Fed had been very aggressive and the overall scheme of things, prime is artificially low and it continued to be so and obviously the recent actions continued to show that as well, so we basically sat down with our management team and started to talk to our customers and said, in a 5% prime and now at a 4.5% prime, there becomes a time when customer for all of us to make a fair profit we need to put some bottoms to those rates and we started that initiative. We started it first with credits that had higher risk ratings and we've spread that throughout our portfolio now where we've just gone on a case-by-case basis and looked at each credit and said that this is where it's got to be as they've matured or as they had reasons to ask for new credit and it's helped us substantially in times of a flat rate prime which we were into until just recently. We've been able to increase our asset yield by a fairly significant amount and we expect that to continue in scope and in value as we go forward.

The market because of what it is these days I think the whole banking industry realizes that when you look out there and you see banks as Chuck alluded to, offering 4% CDs and you have a 4.5% prime, pretty hard to make money on that, and haven't figure out how to do that yet unless you've got the ability to go in on your floaters, floating rate loans and just say, we're not going to continue to follow this down the path. So it's been very significant for us. We expect to continue it and most importantly, the way the market is right now, I think customers understand that there's got to be some limit as to on your floating rates as to how low you'll go.

Can you just give us an example of spreads over prime today versus a year ago?

I think it's more probably appropriate, Jon, to say where we have somebody who was let's say half under prime, floating, or a customer that was at prime floating, whereas right now they would be either earning 4.5 or 4, from time to time we've gone in with those customers when possible and put a 4 or 5% in there. So that a customer normally would be half under prime let's say at 4% today is at 5%, so they go from effectively from half under to half over, and while we have got a long ways to go, because not all of the credits have matured since we started this initiative, each month we grind through more and more of them and each month, we're able to establish a more profitable relationship on those credits that have floating rates. Now if somebody wants to go to a fixed rate, we'll put some fixed rate initiatives in there as well, and those are probably around 7 or 7.5 depending on whether they go three or four or five year fixed. So it's made a big difference to our yield.

Okay, great. Thank you.

You're welcome.

(OPERATOR INSTRUCTIONS). We'll go next to John Szabo from Flintridge Capital.

Good morning. Thanks for taking the question. I understand it's a fluid situation but do you have any thoughts as to what the impact of the rescue package may be for Mercantile and for the industry generally speaking?

Well for the industry, I think it will have good impact, and again this is Mike. Clearly, the markets are reacting fairly closely to it and it looks like the nine large banks that were told they are going to participate or actively participated, obviously it shores them up a little bit. What's it going to mean for Mercantile and the rest of us medium to small banks I think we haven't gotten enough details yet to know whether or not it's appealing to us whether or not we want to avail ourselves as Chuck indicated and our numbers show that we're still in pretty good shape, well capitalized position but that being said we're going to take a look at every detail of the program as we get to know it and make a decision on whether or not it's right for us and our shareholders and customers.

Well I guess I'm just looking on Bloomberg right now, Paulson was quoted as saying that he anticipated investments in thousands of banks. So --

Yes. Yeah, I saw that.

I would presume that the same sort of structure and rate would be available to you.

Yes. Well and you see what I saw was 5% preferred with some escalators over the course of three years but there's also the warrants and there's also some other covenants in there that we want to make sure before we say publicly boy that's for us or boy that's not for us, we need some time to digest them and we're not in a situation where we need to do something today, but we certainly will take a very very steady look at the program.

Right. Well I think on the last conference call you talked a little bit about trying to balance the capital constraints with, I think what you said at the time was some perceived opportunities in terms of lending. Do you still feel that way or sort of where are we with that ?

Well, we are being very very careful with the lending program. Not only obviously from an asset standpoint, but also to make sure that capital is utilized in the very very best manner, and there are a lot of opportunities to lend money right now. There's a tremendous amount of demand out there because everything you've read is absolutely true. Every bank that pretty much every bank is in the same mode that we are, so there are larger banks that are much more aggressive than we are whereas we are working with our customers and our existing customers and taking care of them and being very very judicious on any new customers, some of the larger banks in our market are especially if these involve Real Estate deals are asking the customers to exit. So there's some very nervous and upset customers who we would like to take care of, but just because of capital constraints right now we can't, or we don't want to because we want to make sure that we can take care of our existing customer base. So that being said, it behoove us to take a look again of the TARP program and see whether or not those particulars make sense to us.

Well, I guess one thing that I'm a little bit concerned about with regard to community banks generally speaking is that this level of government intervention could effectively level the playing field among all of the banks, so you guys have done a good job in terms of identifying the problems and it appears that you're going to get through this okay, whereas others who maybe didn't quite make the same level of good decisions might end up surviving, and do you have any thoughts as to how that might play out or do you think that you still have a relative opportunity to take market share and grow coming out the other side of this?

Yeah, I think that's a really good question and the answer is if we had an hour I would go through the numerous thoughts I have about that. I mean, I think it's clear that that's a concern, the concern that you said but I've also done a lot of reading and I guess I have to and I don't want to just go all the way down to just speculating here but I would hope that this has been well thought out enough so that if the banks are so weak going into this program that quite bluntly that there may be those banks that want to avail themselves of this program that are not going to be allowed to, or even if they do, from what I understand, at certain levels of capital that they inject in, the particulars get, the covenants get more onerous. So I hear what you're saying. I think we're trying to be as well run and conservative as we can getting through this asset quality crisis. We'll come out of it and we'll have great opportunity. We've managed to keep our staff and that's a really important thing because a lot of our competitors have lost some very good people and have trimmed some very good people so we'll be poised one way or another to come out of this thing pretty strongly and I appreciate your question and I'm not trying to dodge it because I really have lots of thoughts on it but I'd really like to if this was a week later I'd have more information but I really want to see all of the particulars of the program before speculating too much on it.

Fair enough. Just one last thing. So what gives you the comfort that you think we're kind of peaking here in terms of the asset quality issues? I know just mathematically it looks like you had a flattening in the level of non-performing loans but what makes you think we're not going to get sort of a reacceleration of that down the road? I mean, is it just the fact that you've looked through every loan or every major loan in your book and you feel like even under trying circumstances it's not going to get worse? I mean, what specifically can you share with us that gives you some comfort there?

Well I think a couple of things. I think as far as a general overall economy goes, I think there's certainly room for things to get worse. There's no doubt about it. You look at now everybody says, I guess we are in a recession, and there's clearly recessionary activities going on and indications going on out there, but I think where we get a little bit of cautious optimism is again, if you've listened to our conference calls for the last year, a year ago we were one of the first banks that came out and said we see weakness, we started really down grading a lot of credit and really attacking them, working with them and saying look, we've had to work these out or do what we got to do and the cautionary optimism we feel is that looking at that portfolio this last quarter, we saw not only fewer credits migrating down into the non-performing but we saw some significant upgrade in some of the larger relationships and as we've always said one of the things that we report we did report this time so I can give you an estimate number but it still remains about 36% of our non-performing assets remain contractually current and what you should take away, most banks don't talk about that because that's a pretty high number so some of those credits have gotten better over the last few quarters because we worked with them, we've shored them up. They've done some things that they needed to do internally and so that gives us some real optimism. Now, that being said though, there are, as I said in my comments there are clearly stresses in the environment and we've got credits that like every bank does that if they continue to get stressed, they could be downgraded, so I don't think, I'm not here to declare that globally or the economy of Michigan or the United States as turn the corner but as far as our loan portfolio goes we're seeing some positive rather than some negative trends for the first time in a few quarters now.

Well was that related to asset values, so in other words, the thing that kind of stopped it from getting worse was it because we've hit bottom on asset values or was it because the underlying cash flows are improving or what? Fundamentally what is the reason for this?

It was a little bit of both. For example, we had some credits that we picked up more collateral value where we came in and said that we need to get more collateral. There are some credits that their cash flow has improved where we looked at it, we put them on the watch list or they were non-performing because boy, we were just unsure of their cash flows. We have one Company that sold and the new Management has done a better job of running the Company, has given us more months of consistent cash flow to show that they can make those payments so it's a little bit of everything. Really none of it was to my knowledge where we said boy, we have a piece of collateral and the value of that went up. It was generally we need more collateral borrower and the borrower brought more in and/or their cash flow improved enough where we said it's consistent enough now, they've always made their payments but let's move it up because we can feel pretty strong about that cash flow continuing.

Okay, thank you. I appreciate it.

You're welcome.

We'll take our next question from Daniel Cardenas from Howe Barnes. Mr. Cardenas, your line is open.

Good morning guys.

Good morning, Dan.

Can you comment on the GM plant closing in Grand Rapids how that would impact you guys?

Well, Dan, we could barely hear you but it sounds like you're talking about the GM plant closing and everybody at Mercantile Bank feels very bad about that. That plant has been part of our city for a long time, and it clearly is not going to be good for the city in general although employment had been steadily declining there over the years, but it's about 1500 jobs that will be out of here by the end of next year. Directly to Mercantile, it isn't really going to affect us from a standpoint of we don't have to our knowledge any customers that are directly supplying that stamping plant. Being that it is a stamping plant, we look to maybe we had a couple, we thought we might have a couple steel suppliers there but doesn't look like that's going to be affecting us. I think the way it would affect us is obviously like all banks. It makes the local economy a little more challenged when you see that go away in a year and a quarter for now.

Thank you. Can you also talk a little bit about in your terms of your loan portfolio your loans, your primary loans that are at or near their floors and can you give me a percentage as to what percentage of your portfolio that could be and whether or not the floors appear to be holding?

Dan, this is Chuck. I think looking at the numbers if I recollect, I think we had about 65 to $70 million in prime based loans that did not reprice downwards with last weeks rate cut. Now that number should be drilling as Mike was talking about by us going with our renewals and with our new loans coming into the bank that we are putting considerably more floors in there and obviously in some cases actually raising the rate. So it wasn't a huge number with regards to what just took place, but we would expect that number to increase as we go forward.

Great. Thanks a lot.

(OPERATOR INSTRUCTIONS). We'll go next to Louis Feldman from Wells Capital Management.

Good morning.

Good morning.

A couple of questions. Could you give us a little more color on the loans that you said were turning to the performing status and what was going on there? I mean, you stated a minute or so ago that they were, that certain credits were showing stronger cash flows. Was there any other issues that had you return them to performing status?

This is Bob. I think as Mike mentioned previously, situations with a couple of credits, there was changes in ownership that brought in some new expertise to the table and were able to turn around the operating performance of the companies and in other cases more collateral brought to the table. Certainly a mixture of things that allowed certain to be upgraded including both proven to cash flows and operating performance as well as a collateral lateral position that allows us to mitigate some impaired loss of that established and return the credit to an accrue based performing status loan.

Okay. Second off, can you touch on your headcount in terms of the fact that it's been jumping around a bit over the last few quarters?

Yeah. This is Mike. Headcount has been fairly steady. I think we're at 307 FTEs and we expect to be around that area or slightly less by the end of the year, and we don't have any growth plan as far as FTEs for next year and if we continue to see our growth being very very modest, we may even be able to reduce the headcount a little bit from there based on some initiatives to consolidate some jobs and improve productivity but it's not going to be a major reduction.

Okay. And then lastly, can you touch on the amount of time that your OREO is spending on the books, what the flow through is like?

Well, it depends. It's all over the Board. We have some OREO and Bob can jump in and tell me if I'm wrong, but we have some OREO that will stay on for six, nine, 12 months. We have some that we had one the other day which was a gas station type of deal that once it got the OREO, and we got out of it in a couple months so it's a really fluid situation and it's very very difficult in some cases depending on where the Real Estate is located and trying to find to be honest, trying to find a value. There are some pieces of OREO you get and they sell fairly quickly and they sell for prices that you'd expect based upon appraisals and then there's others that you end up having to work a lot harder and take a lot longer to sell.

I think residential real estate certainly remains challenged and you have just the sheer stock that's in the pipeline right now and the marketplace is creating a situation, some segments of the commercial real estate tends to move a little faster, as Mike mentioned certain pieces of real estate that are in high traffic locations or show some underlying promise to the potential for business going into that location, those tend to move a lot faster as we saw in this past quarter but it is all over the Board depending on the type of property and obviously the location.

In terms of residential real estate, what is the current inventory? What would RMLS say was inventory of housing at this point in time within your footprint?

There was a study published a couple weeks ago by one of the local or commercial real estate companies that studies this, and the inventories are obviously growing. I think they mentioned certainly several years of inventory in the marketplace and pipeline right now and residential Real Estate and you don't really see a whole lot of new building permits and activity going on so the pipeline is somewhat shut off in terms of new stock going into the pipeline but it's a matter of working through what's out there right now, what's in partial stages of development to keep it start coming back in the other direction.

Did you hear you correctly, several years worth of houses ?

Yeah.

Okay. Great. Thank you very much.

You bet.

At this time we have no further questions in the queue.

Well thank you all, again, for your interest in our Company and we will end the call at this time. Thank you very much.

This concludes today's conference. We thank you for your participation. You may now disconnect.