Mercantile Bank Corp (MBWM) 2008 Q4 法說會逐字稿

Welcome to the Mercantile Bank fourth 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 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. 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 all the lines to questions. At this point I would like to turn the call over to Mr. Price. Please go ahead, sir.

Good morning everyone, and welcome to the conference call. As expected, the unrelenting economic pressures that continued throughout our country in the fourth quarter impacted the profitability of our bank as we expected -- probably impacted most banks to some degree. While we are disappointed that nonperforming assets continue at elevated levels, we remain confident that our loan administration is mitigating the situation in very meaningful ways. As we analyze our 2.60% nonperforming asset ratio in light of the severe recession we are experiencing, we believe our overall loan administration has prevented a far more dire situation. The quarter had some very positive developments. Many of the loan pricing initiatives implemented in previous quarters had significant positive impact on our margin. Chuck Christmas will expand on this issue in his comments in a moment. Bob Kaminski will as in most recent quarters give an expanded overview of the dynamics of our loan portfolio for the fourth quarter. Then we will have a question-and-answer period to complete the call. At this time, I would like to turn it over to Chuck.

Thanks, Mike. Good morning, everybody. What I'd like to do, as typical, is to give you an overview of Mercantile's financial condition and operating results for the fourth quarter of 2008 and all of 2008, highlighting the major financial condition and performance balances and ratios. We recorded a net income of $0.3 million or $0.04 per share during the fourth quarter of 2008 compared to net income of $0.1 million or $0.01 per share during the fourth quarter of 2007. While this past quarter represents a decline in net income from the $1.1 million recorded in the third quarter of 2008, it was 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 primarily to a much smaller provision expense and an improved level of net interest income.

We recorded a net loss of $5 million or $0.59 per share for all of 2008 compared to net income of $9 million or $1.06 per share for all of 2007. The decline in net income is primarily the result of a significantly higher provision expense and a substantially lower level of net interest income. The higher provision expense in 2008 versus 2007 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 which culminated in significantly higher levels of net loan chargeoffs during 2008. The lower level of net interest income in 2008 versus 2007 primarily reflects the impact of the steep decline in interest rates that began 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 liabilities subject to repricing, combined with an increased level of nonperforming assets and a very competitive banking environment, we experienced a decline in the level of net interest income, which more than offset the growth in earning assets. More recently however, the level of net interest income has increased significantly, and it is a trend we believe will continue in future periods.

Net interest income during the fourth quarter of 2008 totaled $12.5 million, a decline of $0.6 million from the level during the fourth quarter of 2007. However, it is $0.8 million higher than the third quarter of 2008 and $1.9 million higher than the second quarter. Net interest income during all of 2008 totaled $46.2 million, a decline of $9.3 million from the level earned during all of 2007. Average earning assets equaled $2.12 billion during the fourth quarter of 2008, an increase of about $110 million from the level of average earning assets during the fourth quarter of 2007. As usual, the growth in earning assets was led by an increase in total loans.

Our net interest margin during the fourth quarter of 2008 equaled 2.4%, up from the 2.3% margin during the third quarter of 2008 and the 2.15% margin during the second quarter of 2008. The net interest margin was 2.64% during the fourth quarter of 2007. The decline in our net interest margin since the third quarter of 2007 primarily reflects the steep decline in market interest rates that started in late summer 2007. With about 60% of our loans tied to floating rates, we experienced a significant decline in our yield on assets.

Our asset yield is down about 165 basis points over the past 16 months, led by 190 basis point decline in our yield on our loan portfolio. However, our loan yield has recently stabilized as a result of several pricing initiatives we implemented in 2008, and given the market's expectations for the prime and LIBOR rates to remain low and unchanged for most if not all of 2009, we currently believe the yield on our loan portfolio will remain relatively stable for at least a large part of 2009.

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 to date. While our asset yield has gone down by about 165 basis points over the past 16 months, our cost of funds has declined by about 115 basis points. Although deposit and borrowing market rates have declined, our relatively high reliance on fixed rate certificates of deposit and federal home loan bank advances result in a lag reduction in our cost of funds. With about $1 billion in relatively high rate wholesale funds scheduled to mature during 2009, including about $350 million during the first quarter alone, we do expect our cost of funds to continue to decline throughout 2009. These maturing funds carry interest rates that generally range about 100 to 200 basis points above current interest rates, depending on the term.

A relatively stable yield on assets combined with a continued reduction in our cost of funds should provide for improvement in our net interest margin and net interest income throughout 2009. The extreme volatility in financial markets makes it very difficult to forecast net interest income and the net interest margin with any precision. However, we believe the quarterly improvements will be meaningful and will have a significant impact on our profitability.

The provision expense during the fourth quarter of 2008 totaled $4 million, an increase from the $1.9 million expensed during the third quarter of 2008, but a decline from the $6.2 million expensed during the second quarter and the $9.1 million expensed during the first quarter. During the fourth quarter of 2007, the provision expense totaled $4.9 million. The provision expense for all of 2008 totaled $21.2 million, an increase of $10.1 million from the $11.1 million expensed during all of 2007. Our loan loss reserve totaled $27.1 million at year end 2008, or 1.46% of total loans. Our loan loss reserve equaled 1.58% of total loans at the end of the third quarter, and 1.73% at the end of the second quarter of 2008. The reduction in the coverage ratio primarily reflects chargeoff of specific reserves established in prior periods, especially during the first and second quarters of 2008. Bob will have specific and more detailed commentary on asset quality later during the call.

Noninterest income totaled $1.8 million during the fourth quarter of 2008, an increase of $0.3 million or 18% from the $1.5 million earned during the fourth quarter of 2007. Noninterest income totaled $7.3 million for all of 2008, an increase of $1.4 million or about 24% from the $5.9 million earned during all of 2007. We recorded increases in virtually all fee income categories. During all of 2008 compared to all of 2007, service charge income was up about $0.4 million, mortgage banking activity income was up about $0.2 million, and bank owned life insurance policy income was up about $0.5 million.

Noninterest expense totaled $10.5 million during the fourth quarter of 2008, an increase of $0.5 million over the $10 million expense during the first quarter of 2007. Noninterest expense totaled $42.1 million during all of 2008, an increase of $3.7 million over the amount expensed during all of 2007. Adjusting for the one time expense during 2007 associated with the retirement of our former Chairman and CEO, the increase in 2008 over 2007 totaled $4.9 million. The majority of the noninterest expense [accruals] during all of 2008 when compared to all of 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 $3.3 million during 2008, an increase of $2.2 million when compared to 2007. One other expense item of note is higher FDIC insurance premium assessments, an increase of $1.2 million during 2008 when compared to 2007.

Our funding strategy has not changed significantly as we continue to try to grow local deposits and bridge the funding gap of the [wholesale- (background noise)] funds -- namely brokered CDs and federal home loan bank advances. Our average wholesale funds to total funds during the fourth quarter of 2008 equaled 69%. That compares to 67% during the third quarter of 2008 and 60% in the fourth quarter of 2007. The increase in wholesale funds reflects a combination of asset growth with the reduction of local funds, primarily jumbo CDs.

The reduction in our local funds is due to a variety of factors, including depositors having less funds available for deposits, especially public units; depositors making decisions based on FDIC insurance limitations; and very high rate offerings on CDs by our competitors. Some of our competitors are currently offering CD rates that are 150 to 200 basis points above brokered rates. In fact, in order to simply be competitive, our stated CD rates currently average about 100 basis points above brokered CD rates. The brokered CD market remains very liquid and we continue to raise funds as needed at very reasonable costs. Reducing our reliance on wholesale funds is a top priority for 2009, and we will be devoting significant time and efforts to increasing the level of local deposits as we move forward.

We remain in a well capitalized position per bank regulatory definitions with a consolidated total risk based capital ratio of 10.9% and a bank total risk-based capital ratio of 10.8% as of year end 2008. The bank's total regulatory capital equaled about $226 million at year end 2008, approximately $16.7 million in excess of the amount needed to provide for the 10% minimum well capitalized total risk-based capital ratio.

That's my prepared remarks. Certainly would be happy to answer any questions later on. But now I will turn it over to Bob.

Thank you, Chuck, and good morning everyone. My comments this morning as usual will focus on the bank's asset quality. I will start with the review of the asset quality headlines from the past several quarters.

As you may recall, in the second half of 2007, we witnessed a deterioration in residential real estate development and construction portfolio loans. In the first quarter of 2008, there was continued deterioration of residential real estate, plus we identified some deterioration in commercial real estate and C&I loans. In the second quarter of 2008, there was continued deterioration of commercial real estate loans, plus previously identified as distressed including some significant charges taken for degradation of real estate property values. In the third quarter of '08, some previously identified impaired losses were charged off. Additionally, the bank identified some loan upgrades and experienced some payoffs that helped offset the reduced influx of new problem loans.

In the fourth quarter of '08, we saw continued stresses on real estate values, including commercial real estate. Real estate values continued to be depressed, causing the need for additional loss reserves. Auto industry uncertainties are placing some stress on the C&I segment of the portfolio. New nonperformers were mainly those watched credits previously identified with weakness, however. Management and staff continued to deploy various monitoring techniques to ensure appropriate risk portfolio assessment. The staff is working extremely hard to dispose of other real estate and repossessed assets, and we had good plans in place to move the assets of troubled borrowers once we gain control of those assets. Our lending personnel continued to work closely with all borrowers to watch for signs of any problems and act very quickly to try to mitigate risk and solve issues as they occur.

I want to give you some statistics on the portfolio itself. At year end, we had a total loan portfolio of $1.856 billion, which represented about a $14 million decrease from where it stood at the end of the third quarter. Some stratification of the portfolio by loan type is as follows. As I mentioned, we had a portfolio total of $1.856 billion. Broken down, we had land development and vacant lot loans totaling $128 million. We had one to four family construction portfolio totaling $46 million. We had commercial construction of $89 million, one to four family including rental of $140 million, multifamily loans $47 million, commercial real estate owner occupied loans $369 million, commercial nonowner occupied portfolio $513 million, commercial and industrial loans $507 million, and other individual miscellaneous loans totaling about $17 million -- for a total of $1.856 billion. Our loan loss reserve at the end of the year totaled $27.108 million, which was 1.46% of the portfolio. As Chuck mentioned, that was down from third quarter, but that decrease represented a chargeoff of previously identified impaired loans totaling about $2.4 million at the end of the year.

Review of nonperforming assets is as follows. At the end of the year, we had total nonperformers of $57.400 million broken down as follows. Land development residential lots $14.3 million, commercial land development $2.2 million, we had one to four family construction $11 million -- we had one to four family construction $4.2 million (sic), commercial owner occupied real estate $6.5 million, commercial nonowner occupied real estate $14.1 million, and finally commercial and industrial totaling $5.1 million -- again totaling $57.4 million.

Further stratification of the change from the third quarter is as follows. At the end of the third quarter we had total nonperformers of $47.8 million. We had new nonperformers during the quarter of $20 million. We had paydowns and sales of assets totaling $4.0 million. We had chargeoffs of $6.4 million, again showing a net total for the end of the year, $57.421 million, a net increase of $9.6 million.

Past due loans under 90 days at year end totaled $2.6 million compared to $6.3 million at September 30th. The majority of these loans in this bucket represented a reduction -- the reduction in this category represented a move of some loans to nonperforming status and less loans going into this bucket showing a net reduction from quarter to quarter.

Net chargeoffs for the quarter totaled $6.4 million. Of that amount, as I mentioned, $2.4 million was impairments reserved at the end of the third quarter, $2.0 million was for new reserves to those impaired loans, and $2.1 million was newly identified losses. A breakdown of the net chargeoffs is as follows. Land development and vacant lot loans portfolio $1.3 million, one to four family construction $45,000, one to four family including rental $1.142 million, commercial owner occupied $162,000, commercial nonowner occupied $2.491 million, commercial and industrial $1.236 million, and other miscellaneous losses $2,000, for again a net chargeoff total of $6.4 million.

Regarding the provision, as Chuck mentioned, we had a fourth quarter provision of $4.0 million. The breakdown of that provision by loan type is as follows. Land development and vacant lots $489,000, one to four family construction $784,000, commercial construction $30,000, one to four family including rental $885,000, commercial owner occupied $303,000, commercial nonowner occupied $1.1 million, commercial industrial $275,000, and other miscellaneous loans to individuals $73,000, again for a net provision allocation total for the quarter of $4 million.

Those are my prepared remarks on the analysis of the portfolio and I will now turn it over to Mike Price.

Thank you, Bob, and thank you, Chuck, and at this time we'd like to have time for a question and answer period.

(Operator Instructions) We will go first today to John Arfstrom from RBC Capital Markets.

Thanks. Good morning.

Good morning, John.

A couple of questions here. Can you talk about what percentage of your loans are currently at floors?

It is interesting because one of the initiatives that we have done, John, is -- and it is going to be a long answer, but -- a vast, vast majority of our commercial loans that are tied to prime are actually tied to Mercantile Bank prime, and we -- during the first quarter we did not lower the Mercantile Bank prime the last couple of rate moves by the Federal Reserve. So we have artificially put floors into our loans, but by not lowering our prime during the fourth quarter, we have essentially created the fact that those loans tied to Mercantile prime, which is a majority of our floating rate loans, are in fact artificially at floors.

At the same time, John -- this is Mike -- just to amplify that a little bit, we continue as loans mature, we grind through the portfolio in the normal renewal phase, which is really starting to ramp up in the next couple of months. We continue to put floors in every new note that has a floating rate component.

How is that being received -- specifically the Mercantile prime and then also the new floors being put in place?

It has been received extremely well. We talked about the strategy for a long time among our management team, and our strategic planning team. And our employees have done an excellent job of talking to our customer and saying, look, these are very unusual times, the rates are artificially low if you will. In the standard economic model sense you're, a year ago if you were a prime rate customer you were paying 7% to 7.5%. Now you are down into the fours. At the same time, we want to be fair to our depositors and we have cut the deposit rate significantly over that period of time, and we really just didn't feel like to stay competitive on the deposit side we wanted to knock those down anymore. And our customers were very understanding. They understand it is important to them to have a healthy bank, a profitable bank to work with them as partners, and they felt what we were doing very reasonable. And so we are very gratified by that. But we will continue to monitor that situation as conditions change and as we go through this very interesting time of our economic cycle.

Okay. And just a couple more. Chuck, you talked about out of state or you talked about deposit competition and some of the irrational pricing on deposits. Would you characterize that as in-state competitors, out of state located competitors, or both?

A combination of both, John. We have seen it from both those [characterizations].

Okay. And you have seen that gap widen or narrow, or has it stayed the same?

I think it -- during the third and fourth quarters, it was widening. I think over the last few weeks we have seen a little bit of some of those specials coming down. So hopefully as a trend that will continue, but it is still pretty significant.

Okay. And then, Bob, a question for you. In talking to a lot of your lenders and clients, there's obviously a pretty material change in the economy late in the third and early in the fourth quarter. And I am just curious what your reaction is to that as a lender, and how you work to stay ahead of that -- because it seems like some of the banks we talked to may not have that reflected in some of their thinking, and I am curious if you feel like you are ahead of the curve on that.

That's absolutely right. What we've done is for the last five quarters practically, we've tried to be very nimble in working with our borrowers and trying to anticipate where the weaknesses and the stress points in the economy are and how those will be impacting our customers and impact our loan portfolio. We have worked hard with our lending staff to look at those stress points and do analyses of the portfolio to identify loans that have characteristics reflective of those stress points. We continue to do that. We continue to double back and make sure we get current financial statements each month on our customers to look at how the performance is headed, look for signs of further deterioration, and try to be a partner for those customers to try to help both us and them maneuver through these tough times. It is a situation that requires again the bank to be very nimble for us to have frequent communication with our customers and to try to anticipate where problems are going to occur in our region and our economy and how that will impact the portfolio, and try to do some things from a structure standpoint from some enhancements of collateral support standpoint to buffet the loans as those enhancements may become available.

And then just a little different, you talked about the ability to move foreclosed real estate -- and just curious if prices are firming at all, if the number of buyers coming into the market has increased at all, just a little bit of an idea of how that looks?

It depends upon the specific type of collateral. From a residential real estate standpoint, I think that continues to be a challenge for the entire market. From a commercial real estate standpoint, it is really property specific. As you have properties that the buyers may find attractive, those prices are fairly stable and surprisingly so. Others that may not be so attractive -- reflective in the lack of buyers. So really property specific on the commercial side. Residential real estate is the biggest challenge in terms of deterioration of prices regarding that segment of the real estate portfolio.

Okay. Thanks, guys.

Thank you.

We will take our next question from Terry McEvoy from Oppenheimer and Company.

Good morning.

Morning.

Just wondering -- does this rational lending practice that you are seeing in the marketplace, does that feel sustainable? And then connected to that question, a lot of your larger competitors have received capital from the Treasury Department. Has there been a noticeable change at all in terms of how you are competing against those larger customers -- or larger banks, and essentially are they out there lending money post this TARP capital from your perspective?

This is Mike, and I will try to start to answer the question, and certainly if Bob and Chuck have any amplification, I'll have them jump in, but the first part of your question -- we believe the way the economy is now, and we believe that 2009 at least the first three quarters are probably going to look an awful lot like 2008, and we also think it is going to look like that on the lending front. I think banks at this point are having a hard time -- even if you want to deploy capital in the forms of loans, it is very difficult out there to get comfortable in finding a whole lot of industries right now that you want to go out and make a lot of loans to. And that being said, there are certainly good customers out there and we continue to look at them and we continue to bring new customers into the bank when that is prudent to do so. As far as banks that have received TARP and have they acted any different than before they got TARP or before or now, I would say that it is really too early to tell. We certainly haven't seen anything specifically change, and I think it is for the same reasons, it is very difficult sledding out there right now. And so we haven't seen any change in behavior as to our competitor, and I think whether banks get TARP or where banks don't get TARP, I think as bankers we have all learned that we just came through an unsustainable period of time when competition for bank credit -- for customers by loans or by lenders has just got too intense. We lost a lot of rationality and pricing and structure. We have been talking about this now for a couple of years. Fortunately for us, we have tried to hang on to our structure integrity as much as we could, but we were the first to admit that we joined in to the pack of wolves bidding loan prices down. And quite honestly, we just said, whether conditions get better or not, we are not going back to those days, because it is unsustainable and we all I think as bankers learned that lesson. From my chair, that's what I see. I don't know if Bob or Chuck have anything to add to that.

Mike made some good points, and what we want to focus in on is good customer relationships and customers that bring to the table their loan portfolio of credits, as well as their deposit balances to build a relationship between the bank and the customer. Some banks are after these transactional deals that are just loan for loan sake and we want to make sure we shy away from that to build the bank based on the full package and full menu of needs of the customer and what the bank has to offer to them. Banks are protecting their good customer bases, trying to take care of those good customers and make sure their credit needs are taken care of, and beyond that trying to go out and bring in new business. As Mike mentioned, the credit quality is certainly a challenge right now, and so we are all just trying to make sure we take care of the good customers we have and service those customers and let the economic storm somewhat pass by.

Just one other question. For a while now, MBWM has traded at a noticeable discount to its Michigan peers. So it is nothing to do with being located in the state of Michigan -- it has to be something within your operating strategy, balance sheet, et cetera. As you plan ahead and -- the dust settles, do you expect to see any changes in that operating strategy, and I guess specifically, with the percentage of your loans that you are funding with FHLB advances and brokered CDs, that number going up -- do you think that ultimately is working against you? Does it really come down to just raising traditional deposits in a very competitive market?

That's a good question, Terry. And let me attempt to answer a little bit from the standpoint of the overall global strategy of the strategic planning group, and the board during the last, I am going to say 1.5 to two years. And the first thing we wanted to do right and focus on intensely was asset quality issues as you might imagine, but we also wanted to get our margin up by making sure that loan pricing was rationalized. We went through like most banks and we started doing this before a lot of banks if you remember. We saw the storm coming in the first quarter or second quarter of last year, '08. We put a lot of money in loan loss provision. We downgraded a lot of credits. The problem with that is that you downgrade a lot of credits, you can't immediately rationalize the pricing to the increased risk rating. We spent a lot of time during the last three quarters of 2008 doing just that, spending a lot of time on the floor issue which we talked about, rationalizing the pricing, changing loan policies and getting that squared away. Those things are having tremendous impact right now in a very, very positive way. You followed our bank for a while and you know that typically in a time of extremely rapidly falling rates, our asset yield usually goes way down. We have actually been able to stabilize that in a way we have never been able to do that before. That gives you a little bit of a background.

That that being said, we are frustrated with the stock price as well, because if you look at our peers and you look what is going on in the Midwest, in Michigan, and eventually going through the country -- our nonperforming asset level, which isn't acceptable to us, is fairly reasonable for all things considered. We think we are getting some very, very good things in place to get that reduced down. But that being said, the issue we really want to focus on this year, and Chuck touched upon it earlier, is reducing our dependence on the wholesale funding, because that's got to be in our opinion the reason we get discounted and it would be a reasonable assumption to make. Unfortunately for us, we had driven that wholesale funding reliance number down to a low 60% prior to this economic crisis. But now with people going through this crisis, a lot of our customers have less cash than they normally do. They're been having to use that cash. There have been some customers -- while we have new accounts because of FDIC insurance concerns, we have lost customers for those same reasons. All those things being said, it has worked against us to raise that level back up.

But as part of some of our loan changes that we've made, we have going be more diligent and vigilant to either putting minimum deposit balances with every loan requirement that we have out there. We are going to spend a lot more time advertising structuring products and focusing on getting local deposits in the door. It is a frustrating and some times counterintuitive thing for us to do, Terry, because as Chuck mentioned before, our local deposit base -- we have some banks that are, I guess in need of liquidity in a very bad way, because they're bidding up local rates to rates far in excess of what we can fund nationally through wholesale funding. So there's part of us that says we need to do this because we need to make our bank look better to the outside world, but it is a very tough thing to do because at the same time it puts pressure on your income statement because you're basically getting into the dog fight with some of these other banks with unreasonably high deposit rate. But that's for us to work out and to challenge and to tackle. We are going to do it and we are going to make it happen.

Thanks for the insight. Appreciate it.

You bet.

We will take your next question from Brad Vander Ploeg of Raymond James.

Thanks, good morning.

Morning, Brad.

I was just curious, other than the Mercantile prime that you mentioned, are there any other loan specific pricing initiatives you put into place, or is that the primary one?

That's one of an arsenal of many things we did -- in a couple of previous answers I mentioned and I will cover them again here. What we have tried to do is look at loan grade and do a better job of making sure that we are charging an appropriate interest rate and fees on the loans that have been downgraded. Obviously, like a lot of banks, we've had a lot of loans downgraded in the last 1.5 years, and we are just, in some cases just now getting that opportunity to reprice them, and in the last couple of quarters especially. That has been huge for us. The ultimate floor rate that we put in, all new loans that we have booked over the last six months -- that has helped us. We have instituted pricing model that our people here have done a great job of getting that up and running. That has helped as well because it gives us ROE targets to shoot for, and there are other minor ones that I won't go into, but all of those things together have had tremendous impact and has started to lift our margin. As Chuck said earlier, as we grind through the repricing of our liabilities at much, much lower rates, we like the way the trend of our margin looks for 2009.

And I know you touched on this a little bit before, but how much do you worry about the possibility that maybe people are accepting this now just because credit is a bit tighter, but as things get better toward the end of the year hopefully that there might be some animosity toward that type of policy? Or does it really seem like true acceptance at this point?

That's a great question. I think the honest answer is that I don't think any of us will know until things start to look a little bit better as you allude to, and I would love to be challenged with that next quarter. But the real key here is communication and working closely with our customers. We have some very loyal customers. We have some very long term employees who work with those customers. They understand now if prime was 10% and a year ago it was 8%, and we decided when it started to come down we weren't coming down. That's a different situation, but most businesses now realize that lending in the 3.5% to 4% to 4.25% range -- that's a pretty good deal. And if Mercantile doesn't go all the way down to a prime of 3.25%, that's not as big of a deal to them as you might think, because they feel that it is a very fair rate to have. They understand that community banks make most of their money by margin.

And it doesn't take a real long explanation to say if prime is at 3.25% and they can open the Sunday paper, which they can here in Grand Rapids, Michigan, to see money market rates at 3% and CD rates at 3.25% to 4%, I am the first one to tell them I'm not that smart as to how to make money at that negative arbitrage. I think customers understand it pretty well. But that being said, we are not patting ourselves on the back and saying that the battle is over and we will sleep well at night thinking this is something that will forever be the case. It is our plan not to be. It's the unusual times and we are going to watch it very, very closely as things start to get better.

All right. And just a detailed question on the nonperforming loans and chargeoffs. I was curious -- you got a number here in the press release of $4 million for a number of things, and I was wondering if that's for all of those things combined which are loan paydowns, sales, and foreclosed real estate, or if that is just -- I am trying to get at the amount of nonperforming loans and OREO you sold during the period.

As I mentioned, the figure was $4 million -- that was a combination of things. There are a couple of credits that were upgraded because it improved performance, but the majority of that $4 million was through the sale of distressed assets, and also some loans that were nonperforming that had paid off.

Okay. So it is a combination of loan and OREO sales then?

Correct.

Okay. And then Chuck, what is the current run rate for FDIC insurance expense?

Oh, I don't have that handy but I can get that to you a little bit later.

Okay. That would be fine. Because it went up during the year, right? So that $1.2 million increase is not necessarily a full-year impact?

Yes, that's correct. There's a -- it is definitely changing and of course you are starting with the first quarter of this year. Obviously it has gone up yet again.

Yes.

So --

Okay. And then maybe lastly, Mike, if you could just talk through a little bit the decision to participate in TARP. Did you have any conversations with the Treasury or is that just something you not, you weren't interested in from the get go?

We really haven't released any information regarding TARP or really any other capital management strategies at this point. And it is one of those issues that we are constantly -- and I am talking about our capital management strategy -- talking about and looking at and updating. We are in one of those unique situations -- not unique, but a good situation, where we don't need to take TARP. We have some flexibility there, and at this point I guess we are just going to continue to keep the public discussion of it down to a minimum until we are ready to share what our capital management strategy is going to be going forward.

Fair enough. Thanks very much.

Thank you.

We will take our next question from Eileen Rooney of KBW.

Good morning, guys.

Morning.

Most of my questions have already been asked. I guess just one follow up on the margin. What was the impact from interest reversals on nonaccruals on the margin, I guess this quarter versus last quarter?

Yes, I think the reversals have been pretty consistent at least from the third and fourth quarter, Eileen. It is probably, to put a dollar amount to it, it is probably right around $0.25 million a quarter. $200,000 to $250,000 per quarter.

Okay. That's all I had. Thanks.

Was there anything further?

Nope. That's it.

Okay. Thank you. And we will take our next question from Daniel Cardenas of Howe Barnes.

Morning guys, how are you?

Hi, Dan.

Just a quick question on watch list trends. I saw your -- it sounds like your 30/89 day bucket has decreased a little bit, but what's the internal watch list trends look like?

It is a pretty fluid number. As you see credits coming in, going on a watchlist, moving to nonperforming ones that go the wrong direction, ones that go the right direction. We maintained a close tally on the loans that are just prewatch list as well, and you look at the credits that exhibit some signs of stress, and ones that aren't quite on the watch list yet. And we continue to see good trends there. So in terms of the feeder in the watch list, we are encouraged by what we are seeing there, and perhaps as you get into the latter half of 2009, that whole segment of loans that are exhibiting signs of deterioration will continue to reduce.

As Bob said, it is good news, bad news. The good news is we've identified fewer new members of the watch list, which is always a good thing. The bad news is obviously the continued stress in the economy out there has made some of the watch list credits a little sicker if you will, so that we continue to increase some provisions for some of those credits. And then we expect the first quarter to be a lot like the fourth quarter. And so it is nice to have fewer to quarantine, but those we have quarantined are seeing some real stress out there. The good news overall for our organization is that we believe it is a very manageable number, and with the margins now going in the right way at a very significant level, we will be in much better shape to withstand some of those battles as well.

Any certain industries causing you concern right now?

As you might imagine, we've done -- our guys and ladies have done a good job internally of identifying anything and everything that we would have concerns about, and one of them would be obviously the automotive industry. We are not huge into the automotive industry, but if you start looking at one off and two off levels and start thinking about even transportation companies that have the automotive as customers, you start to have some concerns about them. But we have done some proactive research on our portfolio and put things in place, and obviously at this point you see retail sales -- the numbers that came out today were not good, not that anybody expected them to be. So I had think we really are paying attention to automotive, but I don't think there's an industry or an area right now that any bank has that they aren't concerned about, just because of the general economy is just taking such a -- it is a tough hit out there.

Our lending staff, our credit staff, and loan review staff have done a really good job of as I mentioned of previously being nimble -- being able to generate data on the portfolio, to slice and dice it, to look at various segments and industries that we see on the horizon, there may be some problems, or warning signs for the future. I think we continue to do a good job of being proactive and looking at the portfolio every week, every month to make sure that we have our arms around it and are looking to see where the trends are headed and to be able to provide the information to the board as to the trends as we continue on in 2009.

And last, geographically, I mean are you seeing problems increase in your eastern part of the franchise?

This is Mike again, and again Bob can add to it if I forget anything. We saw out of our Washtenaw office probably about 1.5 years ago an increase in some watch credits over in that area. They've had to do primarily with residential real estate development and those have been quarantined and worked on, and in some cases worked off or charged off. I would say we don't see anything that we would say was region specific, where we are saying we don't have any problems in this region or we have an inordinate number in anything. Clearly the southeastern side of the state is being challenged even more than the western side. Fortunately for us, we don't have a big exposure over there. We probably have -- in both our Washtenaw and Oakland offices -- and check me Bob, if I'm wrong -- but I think somewhere around $80 million in loans. While that's not $0, they're generally in pretty good shape other than the aforementioned ones I talked about in residential real estate. As you can imagine, it is hard for whether you are in the eastern side of the state or western side to find good new customers to lend money to right now. So, we are not seeing a lot of growth on that end either.

Thank you.

You bet.

(Operator Instructions) We will go next to Stephen Geyen with Stifel Nicolaus.

Good morning. Just two quick questions. Since the big jump I guess in nonperforming loans occurred late in 2007, early 2008 at least on a percentage basis.

Right.

Are many of these properties now moving into resolution, considering the long foreclosure time in Michigan and wondering what it might mean for nonperforming loans, nonperforming assets, and OREO going forward?

That's a great question because as you know, in Michigan there is a redemption time that you have to work through. That's exactly what is happening now. The fourth quarter was really the first quarter we saw a significant number of properties both residential and commercial that came out of foreclosure and redemption that we are able to get on to the market. As Bob said earlier, some of those pieces have moved fairly easily, in some cases surprisingly easily at reasonable prices as opposed to appraisal et cetera. Others are have been more challenging, and a lot of it again just depends on location and the dynamics of the property. But I think the good news for us is that there was a lot of stuff we were unable to bring to the market, so to speak, for the first half of '08 that we will be able to bring to the market in the first half of '09 here. So we are looking forward to that.

And I guess you guys have talked a little bit today based on various questions -- the desire to increase local deposits. Just wondering what ideas are you floating to increase local deposits, and I guess said another way, what are you seeing today that maybe you didn't see twelve months ago?

We are looking at products, we're looking at structures of those products, enhancing existing products, maybe adding new products. We are looking at our rate scenarios across the board, all sorts -- really there isn't anything that we haven't considered or we aren't thinking about doing. We haven't been traditionally an organization that has done a lot of advertising and promoting of our local deposit rates. That's going to have to change. We want it to change, and we are going to make the commitment to do that. So internally, more cross selling and profiling, all sorts of things that we need to do. There's no magic bullet to raising local deposits, just like there's no magic bullet to increasing our loan yield in a drastically reducing environment. But when you put the focus on things with the group of people that we have, and we sit down and put a strategy in place, I am pretty confident we can do some real good work here. And clearly the market is going to have a lot to do with it as well. There isn't a lot of extra money floating around both from our retail and our commercial market here in Grand Rapids. We are going to have to be competitive on rate. We know that, and structure, and that type of thing. I think all of those things put together, we will be rolling out some real opportunities to raise it, and I think Chuck wanted to add a couple of comments.

Thanks, Mike. One of the things we have to deal with more from an outside standpoint, and what I think shocked the system, and we started seeing some significant dollars leave the bank is with regards to not only Mercantile's financial condition, but that of the entire banking industry. Obviously we had a tough first two quarters last year, lost money. We really didn't see a significant outflow of funds as a result of that. We certainly had a lot of discussions, a lot of lunches, a lot of conference calls. We're happy to do that as we try to -- obviously talking about our larger depositors now. What shocked the system was the failure of IndyMac Bank and the other banks that followed. That really grabbed the attention especially of the municipal treasurers and some larger depositors as well. I think -- I won't call it panic, although some people it was a panic -- but that was a huge ripple effect of -- I think of the people's confidence, not just the Mercantile talking to other bankers of the entire banking system, and just a dramatic risk diversification that is taking place with regard to larger depositors. So I think part of being able to increase our local deposits, and it is not the only thing but it is an issue, is our overall health but also the overall health of the entire industry. We have to get people back, having confidence of having dollars in banks over the insurance limit. Most of the people, the significant dollars that we lost, we didn't lose the entire relationship. A lot of times they just reduced their exposure, many times down to the $250,000 insurance limit. But we had customers that had $2 million or $3 million worth, and they still have over $1 million with us or $1 million with us, but obviously we did lose some depositors, just as they felt it prudent given the times to go ahead and diversify. There are still good customers at the bank, and hopefully at least as we improve, which we think we will, but hopefully the rest of the industry comes along with us, to get their confidence back.

Great. Thanks, guys.

You're welcome.

And gentlemen, we have no further questions at this time. Mr. Price, I will turn the call back to you.

Thank you, Dana. Again, we continue to work closely with our customers who have been severely impacted by these tough economic times. We know there are more challenges ahead. We feel very comfortable and confident to tell you that we're continuing to make improvements in our organization in many, many areas. We thank you for joining us today and we appreciate your interest in our company. Thank you.

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